Archive for category Merkel

Greece and the EU

Greek protesters in support of the Syriza party, a left wing party that dominated last month's elections.

Greek protesters in support of the Syriza party, a left wing party that dominated last month’s elections.

In 2008 the global economic crisis unmasked the structural weakness of the economies of southern Europe.  Greece was by far in the worst shape.   In 2010 the EU brokered a bailout deal for Greece, predicated on the country embracing a very painful austerity program.   In 2012 Syriza campaigned against the cuts and urged Greeks to chart a course not dictated by the EU.   Greek voters, skittish about loosening ties with Europe, said no, and Syriza won just 78 out of 300 seats.  Three years of painful recession later and the Greeks have had enough – Syriza won 149 seats, just short of an absolute majority.  The left wing party joined in a coalition with ANEL, a small right wing conservative party to form a government.

Greece has a debt of about $500 billion, 180% of it’s GDP.   60% of that debt is owed to the Eurozone, so a default would have serious, though not disastrous implications.   Very little of that debt is held by Greece.   After the election Greece’s 10 year treasury bond yield skyrocketed to over 10%, meaning rising the debt would be prohibitively costly.

Syriza’s leader, new Prime Minister Alexis Tsipras, vows to keep this campaign promises, all of which violate the conditions of the bailout.  These include increasing the minimum wage, cutting property taxes, increasing pensions, rehiring fired public sector workers, and giving free electricity to those “suffering the most.”   Since he doesn’t want more debt, the only way to do that is to print money – but Greece is in the Eurozone and monetary policy is controlled by the European Central Bank (ECB).   So what next?

Syriza's leader Alexis Tsipras

Syriza’s leader Alexis Tsipras

One might wonder if Tsipras is out of touch with reality, wanting to increase spending to get out of debt.   But he makes a good point that austerity simply increased the scope and depth of the recession.  The ‘bailout’ benefited Eurozone banks more than the Greek people.   He believes his policies would stimulate the economy so that Greece will be able to pay back its debts and show itself to be solvent.

Unfortunately the Greek economy was built on sand – debt and public sector employment hid the fact the Greek economy is structurally flawed.  Just ending austerity won’t change that, nor alter the dynamics that created the crisis in the first place.

Last week Tsipras and his Finance Minister Yanis Varoufakis visited European leaders to try to assure them that they weren’t going to rush out of the Eurozone, and to convince them to support a bridge loan to fund the government through September.   On Sunday Tsipras said that the Euro was a “fragile house of cards” and if the Greek cards were pulled it would collapse.   On Wednesday Eurozone finance ministers are meeting to discuss what to do next.

The Euro is not likely to disappear whatever Greece does.

The Euro is not likely to disappear whatever Greece does.

Tsipras is playing a game of chicken – pushing the EU to accept his policies and offer help in exchange for Greece holding on to the Euro.  More importantly, if he were to leave the debt owned by Eurozone banks would become toxic, threatening a banking crisis.

Still, the threat to the Euro is much smaller than it was back in 2010, or even during the election of 2012.   At that point high bond yields threatened a number of countries, especially Spain and Italy.    Today Italy’s bond yield is 1.76%, while Spain’s is 1.38%.   Those are below the US yield of 1.94%!  This suggests the fears of contagion no longer exist and Greece is being treated as an isolated case.   With 19 countries now using the Euro – Lithuania joined last month – it could withstand a Greek departure.

But the Prime Minister does not want to leave the Eurozone, and therein lies the rub.   Greeks know that leaving the Eurozone would put them on a path towards increased isolation and continual crisis.    He’s betting he can arrange a bridge loan through August, and that while Greek debt is high, the Greek economy is small.   The cost to the EU member states would not be prohibitive.

While some European leaders are sounding cautiously optimistic about making a deal with Tsipras, German Chancellor Angela Merkel is having none of it.   While not dismissing anything out of hand, she says it’s up to Greece to come up with a plan.   Tsipras has said he’s working on further reforms designed to mollify EU critics, but it’s unlikely he’ll convince Merkel, who fears this will simply enable Greece to go back to its old ways.

Tsipras and Merkel will meet for the first time this week.

Tsipras and Merkel will meet for the first time this week.

My predictions:

1.  Those predicting the end of the Euro will be disappointed.   Countries are politically committed to monetary union as the best way to assure economic stability.   Businesses and banks – the people who really run the show – are almost unanimously in favor of it.   Now that Italy and Spain are no longer seen as “the next to go” if Greece leaves, the Euro is not in existential danger.

2.   Tsipras and EU leaders, particularly German Chancellor Merkel and French President Hollande, will engage in tough negotiations, but are likely to reach a deal.   It’s in their interest.   The EU leaders do not want their banks to suffer due to the Greek debt they hold, nor do they want instability associated with the first departure from the Eurozone.   Prime Minister Tsipras knows that the Greek economy would be severe crisis if he actually tried to go back to the drachma, perhaps worse than the last few years of recession.

3.  The agreement might work.   Merkel needs to be firm on the need of Greece not just to stimulate their economy, but to restructure it.   Greece needs to develop a productive and sustainable economy.  They do not have one now.  Tsipras has to recognize that reality..

The telling point is that nobody involved wants Greece to leave the Eurozone.   It is in their interest to maintain it, even strengthen it.   It is in the EU’s interest to have Greece develop a sustainable, productive economy.   The bailout and austerity program didn’t work – even though the Greek voters gave it a chance back in 2012.   With some creative thinking, it may be that contrary to expectations, the victory of Syriza may end up being good for the EU.

 

 

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What Next in Ukraine

crash

The downing of Malaysia Flight 17 by Russian separatists in eastern Ukraine put the Ukraine crisis back into the world’s attention, and marked a dramatic escalation in the seriousness of the crisis.  295 people were killed, a civilian airliner shot down, and Russia appears to be at least indirectly responsible through its arming of the separatists.   So where do we go from here?

Here’s the situation: Vlad the improviser stumbled into his Ukraine policy with a series of reactions to the downfall of former Ukrainian President Yanukovych.  Suddenly Ukraine shifted from a tilt toward Russia to a strong lean towards Europe, and Putin’s reaction was to grab Crimea, and then foment unrest in the ethnic Russian regions of eastern Ukraine.   Personally, I get the Crimea gambit.  Crimea was traditionally Russian and give to Ukraine by a misguided Khrushchev in 1954.   But the rest?

Plane parts are spread out over a wide area, consistent with it having been shot down.    Here people in Grabovka, Ukraine wander among crash remnants.

Plane parts are spread out over a wide area, consistent with it having been shot down. Here people in Grabovka, Ukraine wander among crash remnants.

For Putin, who was losing his luster at home, it was an unexpected political opportunity.   He could play the Russian nationalist anti-American card and watch his popularity grow.   Though the West feared an effort to grab all of eastern Ukraine, Putin instead tried to maintain a balancing act.

Knowing that the Russian economy in the era of globalization needs to keep reasonably healthy ties with the EU, he avoided the massive land grab that could have forced the EU into more draconian anti-Russia sanctions.   However, he also sent units from Russian intelligence there to start/support an indigenous uprising, knowing it might flounder, but counting on it destabilizing the hated Ukrainian government and helping keep his nationalist bona fides in place.

For awhile, it seemed to work.   The West seemed to be losing interest in the conflict, especially as it was clear the Russian separatists were not faring well against the Ukrainian military.  At home his stoking of Russian nationalism kept his popularity high. The balancing act seemed to be a bit of political genius.

However, supporting a rebellion is tricky.   While Putin might have been OK with the crisis dragging out indefinitely, the rebels were fighting for a cause.  Angry that Russia seemed to be “deserting them” (read: just giving them weapons and support, but not actively participating in the effort to build New Russia), they exercised more autonomy and, as we know, brought down Malaysian Flight 17.

Obama on the phone with Ukrainian President Petro Poroshenko after the crash

Obama on the phone with Ukrainian President Petro Poroshenko after the crash

So what now?  First, the US has to recognize that there are limited options and all require serious cooperation and even leadership from the EU.  While some in the US huff that Obama hasn’t done enough, blaming the American President for what goes on in the rest of the world, the reality is that US power is limited.

The key is that Russian President Putin knows that the Soviet Union fell primarily because its economy was isolated.   Globalization began in earnest in the 80s, and the rapid connections in the West combined with the economic failures of Communism in the Soviet bloc made economic disintegration inevitable.    If Putin severed ties and focused on building his own internal empire, the result would be disaster.

Moreover, Russia’s future is very much connected to the EU, and Germany in particular.   Earlier this month Germans, already incensed by the monitoring of Chancellor Merkel’s phone calls for years, kicked out a CIA agent who was spying on Germany from the US embassy.   German Chancellor Merkel is clearly not an American proxy; the Germans have become more independent in crafting a foreign policy to serve European interests.  The Cold War is long dead.

Putin and Merkel consult in Brazil during the World Cup finals.

Putin and Merkel consult in Brazil during the World Cup finals.

It is Germany and the EU that can put the most pressure on Putin, and Merkel’s leverage with the Russian President has been increased by this tragedy.   Not only are the Europeans feeling more pressure than ever to turn up the heat on Russia, but Putin has to recognize that his balancing act is a very dangerous one.

President Obama needs to keep rhetorical pressure on Russia and be in close consultation with Merkel, crafting a plan to both pressure the Russian leader but also give him a face saving way to withdraw support from the rebels.   What we do not need is rah rah Cold War style chest thumping, nor do we need to up the ante by dramatically increasing military aid for Ukraine.   That would force Putin into holding firm – he will not allow himself to be seen as giving in to the US.  At best, it would only deepen and lengthen the duration of the crisis.  At first, things could spin out of control.

That’s in no one’s interest, saving the hyper-nationalists on either side.   A gradual reduction in tension, with action more behind the scenes than in the public eye, is the best way out.   So far, the Obama Administration has behaved admirably, keeping up pressure but not being belligerent.   More importantly, the US has learned that we do not need to lead, especially not when our direct interests are not at stake.

Ultimately it is up to Putin – he is a very vain politician, and the West needs to construct a path to de-escalate the crisis so that he saves face.   Recognizing that the Crimea is part of Russia is perhaps part of the calculus.   Putin giving up on any further annexation of eastern Ukraine must be another.

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Generations

ampelmaennchen

I recall the interview in the summer of 1995.  I was in Dresden, and had an interview with an elderly member of the Christian Democratic Union (CDU) to discuss the difficulties of German unification.

In Berlin there was a controversy brewing about the above shown “Ampelmaennchen.”   The icons of East German traffic lights showed a little man with a hate, green and walking to indicate “walk,” and read with hands spread apart to indicate “don’t walk.”   In Berlin the goal of unification meant standardizing traffic lights, which meant doing away with the Ampelmaennchen in favor of the more modern West Berlin figures.

In 1995 this emerged as a full blown controversy, with groups protesting in favor of the Ampelmaennchen and pressuring the Berlin government to back down.   At first it refused, and the Ampelmaennchen became a symbol of a growing East German resentment for what they felt was a take over by the West.   Not that they wanted communism back – only a few aging stalwarts wanted that – but they wanted a new Germany that could be shaped by them alongside the “Wessis,” rather than simply having the West shove a new system down their throat.

As I chatted with the man whose name I forget (I’ve got it written down somewhere if I dug through my records), I told him about how it seems like the “wall in the head” was dividing Germans with as much power as the original wall had divided them physical.  It was Ossi vs. Wessi.   You could tell an “Ossi” (easterner) by their clothes and dental work; it was clear almost all the time which Germany one was from.

 

1961 "No one has the intention to build a wall."  Forty years later: "Many have no intention of removing the wall in the head" (Ossi vs. Wessi)

1961 “No one has the intention to build a wall.” Forty years later: “Many have no intention of removing the wall in the head” (Ossi vs. Wessi)

Moreover, the former Communist party (SED, now renamed PDS – Party of Democratic Socialism) was rebounding quickly in the East.  Most thought it would vanish as Communism was discredited; instead, as East Germans felt alienated in the new system, it quickly became the most powerful political force in many parts of the East.   Was unification failing?

The gentleman had been part of the Ost-CDU, one of the “block parties” which offered symbolic opposition yet had to promise to support the SED (Socialist Unity Party – the Communists) in East German politics.  Many Ost-CDU politicians were distrusted because they had collaborated; others saw it as a way to raise different voices.   Angela Merkel, the most famous Christian Democrat from the East, was not a member of the Ost-CDU, she joined Democratic Awakening (DA) after the wall fell.  The DA later merged with the CDU.

“It’s just a matter of generational change,” he told me.  ” This generation will never accept it completely, their world has changed too much.  As much as they hate communism, they don’t know anything else, and resent demands from the West.  They aren’t used to having to work hard because in communism there wasn’t enough work – ten people did the job one person could do.  That was to avoid unemployment.   Come back in 25 years, you’ll see.”

It is now 25 years since the wall came down. Perhaps most obvious of the change is the Berlin public transportation system.   The idiosyncrasies and annoying detours caused by the wall are gone.   When we went to Potsdam I tried to go the old route via Wannsee.   We got there, but then I found out that  the S-Bahn cuts through the city now, the system is efficient and unified.

The subway system in 1988, the red line dividing the two Berlins

The subway system in 1988, the red line dividing the two Berlins

Now the city is whole, and the wall only a memory

Now the city is whole, and the wall only a memory

I thought of  that conversation in Dresden as I walked through Berlin two weeks ago, noting that it was now virtually impossible to distinguish Wessi from Ossi, or to see where the wall had been.   A top the television tower in old East Berlin it was clearer – the ugly architecture of “real existing socialism” distinguished itself from the more vibrant West.   The S-Bahn stations also showed the difference; in 25 years the infrastructure rebuilding remains an on going project.  Berlin is still a “city of cranes,” as construction vehicles dot the city, rebuilding train stations, neighborhoods and homes.

The architecture of Communist East Berlin can be described as a cross between bland and ugly.

The architecture of Communist East Berlin can be described as a cross between bland and ugly.

 

With “Ossi” Angela Merkel now in her ninth year as Chancellor, her reputation and success has led to a point that she no longer is distinguished by the fact she’s the first woman and first ex-East German Chancellor.   Rather she is Angie, perhaps the most powerful woman on the planet.   She’s compared with Helmut Kohl and Konrad Adenauer.   When Kohl plucked her from the young DA party to become Family Minister on his cabinet, most thought it was purely symbolic – he just needed an Eastern woman.   She’s shown herself to be much more.

In 1990 Merkel would start as deputy premier of the last East German government, then join Kohl's first united Germany government as a minor cabinet member

In 1990 Merkel would start as deputy premier of the last East German government, then join Kohl’s first united Germany government as a minor cabinet member

The notion of generational change is powerful.   The differences have blurred.   The West clearly dominated the change, but not completely.  The old PDS ultimately linked up with disenchanted Social Democrats in the West, who thought their party had drifted too much to the center.   That allowed the creation of the leftist “Linke” party, altering the German political landscape.

Perhaps most symbolic is the survival of the Ampelmaennchen.  Not only did the Berlin city government give up on its effort to standardize all traffic lights to the modern sleek figures of West Berlin, but they decided that as they replace or add new signals in the West, the old Ampelmaennchen figure will be preferred.  Thus the Ampelmaennchen are no longer East Berlin phenomena, they are all over in the West, helping blur the distinctions between east and west.

For the last quarter century cranes have been ubiquitous on the Berlin skyscape

For the last quarter century cranes have been ubiquitous on the Berlin skyscape

Generational change yields new politics; one sees that in the US as well.  A generation ago gay marriage and a black President named Barack Hussein Obama would have been unthinkable.    In Berlin, however, it is profound and communism is very quickly becoming an historical oddity, a short lived failure.

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Merkel’s Faux Victory?

merkel

Germany’s election of September 22, 2013 appeared for awhile to suggest that Angela Merkel would be able to form a majority government, not needing a coalition partner.    That has happened only once in German post-war history:  the CDU/CSU under Konrad Adenauer had a majority from 1957-61.

The result, however, turned out slightly – and only slightly – different.

With over 71% voting, here is the result of the second ballot, the ballot where Germans choose their party preference:

chart

Clearly the CDU/CSU total of 41.5% is far above that of any other party.  But there are a few quirks in the German system.   First, a party has to get 5% to have any seats in the Bundestag.   This means that in the Bundestag the parties on the left earned 42.7% of the vote.   After that and a host of extra seats were figured out the end result in the Bundestag is this:

bundestagseats

(*Aside for political science folk:  In Germany half the seats are apportioned through single member districts, and half through a second ballot with party preference.  However, the allocation of the second ballot seats is done to get the Bundestag to reflect the second ballot results, meaning the second ballot is the most important.   This is done at the state level, not the national level.   Sometimes in a state a party may win more seats in the first ballot than they deserve based on the second ballot result.  They don’t get any new second ballot seats, but can keep the extra seat – the Bundestag is expanded for that purpose.  All parties who get under 5% on the second ballot are denied representation in the Bundestag, but can keep any seats won on the first ballot.  If they win three first ballot seats they get their second ballot representation.  So if the FDP had won 3 first ballot seats, they’d get their 4.8% of Bundestag seats.  They didn’t do that).

So with 630 seats, the Union has a conservative block of 311 seats, while the parties of the left have 319.  Conservatives would protest that the 4.8% for the FDP and 4.7% for the AfD reflect conservative values (though the AfD’s anti-Euro stance is completely opposite of Merkel’s position), meaning that most voters had a preference for a party on the “right.”  Yet those parties didn’t make the Bundestag.

So it’s possible that the SPD, Greens and Linke (left) will form a red-red-green coalition.   That seems unlikely.   The SPD hates the fact the Linke even exists.   Die Linken are getting most of the votes on the left in former East Germany.   In the West the SPD got 27.3% and the Linke only 5.3%.   Here are results from the East:

eastvote

In the East the Linke get 21.2 vs. 18.8% for the SPD.   The SPD has vowed to defeat the Linke, which was built atop the old Communist party of East Germany, and it’s successor party, the Party of Democratic Socialism (PDS).   However, the Linke are not going away – they even got 5% in the West!   Perhaps the SPD needs to recognize that the left is divided in Germany and deal with the Linke.   Twenty years ago that was impossible because the old PDS was still too communist in orientation.   Now that’s faded.

The Greens, also more popular in the West than East, have a strong civil rights background that cause them to see former communists as anathema.  All this has meant that the division on the left has been insurmountable – the Linke were poison.   Yet that hasn’t been true at the state level, and maybe now that the Cold War is nearly a generation in the past the SPD and Greens need to have serious talks with the Linke.

Merkel, on the other hand, is left in a situation where no one wants to govern with her.  From 2005 to 2009 she joined with the SPD for a left-right “Grand Coalition.”  The SPD was hurt by that, and there is virtually no desire within the party to join Merkel again – they have nothing to gain and a lot to lose.  Better to be an opposition party.   The Greens could reach an agreement with the CDU, but on policy grounds they come from a very different perspective.   The negotiations would be tough.  Beyond that, they see what happened to the FDP, who ruled with Merkel from 2009 to now.   In 2009 the FDP had 14.5.   They dropped down nearly 10% to the point that their future as a party has been questioned.   Governing with Merkel could be poison for the Greens.

So Merkel might end up having a minority government, tolerated by the SPD and Greens (meaning they’d vote alongside the government on most issues while not joining it).   That could work, but minority governments are inherently unstable.   If a new Euro crisis emerged, she might not be able to get her priorities through the Bundestag.

So her victory is tainted.   She’ll have a tough time getting a stable coalition partner and may have to rule a minority government.  Or perhaps the SPD will decide that their party is floundering and it’s worth the risk to forge an agreement with the Linke and Greens to create a government of the left.  That would shock the world, but certainly is possible.    Back in 1969 President Nixon called CDU Chancellor Kurt Kiesinger to congratulate him on the election, only to find that the SPD would reach an unexpected agreement to form a coalition with the FDP, making Willy Brandt Chancellor.  It’s possible, though unlikely, that Merkel won’t remain Chancellor.

So today the world reports on Merkel’s victory, and the CDU/CSU as the strongest party in Germany, gaining significantly from their 2009 result.  But thanks to Germany’s electoral quirks, this victory may prove hollow – and it may not be a victory at all.  Stay tuned!

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Why the Euro will Survive – and Thrive

American and British commentators are often surprised, annoyed or dismayed by the fact the Euro trudges on, as both the European Central Bank (ECB) and the core states of Europe do what is necessary to protect the currency and avoid contraction of the Euro zone.   Why are German taxpayers willing to pay so much to protect banks in Ireland, or government debt in Greece, Portugal and Spain?   Why do Greeks accept an austerity program that put them into depression – and in 2012 elect a new government that favors that very program?

First, what is the Euro crisis?    On the surface it’s a sovereign debt crisis – southern European states have so much debt that investors are doubting they can pay it back.  This means that to sell bonds states have to offer a higher interest rate, since the risk is higher.  However, it’s not just a debt crisis.   Consider these bond rates:

bonds

Note how Germany and the UK’s rate has been dipping, meaning it’s easier for them to sell bonds, while Spain and Italy’s cost more – though historically near the average.  Only Ireland and Greece had an extreme crisis.   Those two were caused by very different factors.  Ireland’s deregulation of the financial sector was patterned on American practices, and thus they got hit hard by the bubble bursting.

The problem for Greece is not just debt, but structural weakness in their entire economic system (that’s why it’s always a false comparison when politicians try to compare the US or even California to Greece).

debt explosiondebtgdp

 

The first is telling – there has been a debt explosion throughout the Eurozone, including Germany.   This makes clear that one of the structural aspects of this crisis is a need to reduce debt.    Debt always goes up in a recession since revenues are down and claims for aid increase – yet with the bursting of the bubble it has become crystal clear that debt to GDP ratios above 60% are unsustainable.

The second chart shows that there is wide variation of debt growth since 2008 – but Ireland, Greece, Spain and Portugal have had the greatest debt increase, and are four of the problem states.  Italy’s debt growth is less, but while Italy hasn’t had a debt explosion, they’ve had consistently high debt.

spainitalydebt

 

Italy’s actually made significant structural reforms and was not hit as hard by the recession as others in terms of new debt – yet it’s debt level is one of the highest in the Eurozone.

The problem in Europe is that there is a core set of countries with strong economies that simply have to find a way to reduce debt and a set of weaker economies that have managed to hide their structural problems with debt or financial gimmicks.  The recession laid that structural weakness bear.

Many Americans want to blame European social welfare programs for the crisis, but that’s’ also easily disproven.  The chart showing debt to GDP ratio growth since 2008 shows Sweden actually reducing debt, and the Scandinavian countries faring well.   Germany is running a 7% current account surplus and remains the engine of Europe.   Countries with the best social welfare systems are faring very well, even better than the US.

germany

This is evident in bond rates.   Germany’s 10 year note now has a yield of 1.3 %.  That means that despite high debt levels, investors have faith in German bonds thanks to the strength of the German economy.    The US, UK, Sweden, and France all have yields of about 1.8% – still very cheap.   Ireland’s yield is now under 4%, thanks the EU and IMF recapitalizing Irish banks.   The worst of their crisis seems over – Ireland’s was a banking crisis caused by financial deregulation and that’s easier to solve than structural debt crises.

Ever since the ECB, EU and IMF made clear they’d do whatever it takes to protect the Euro, Spanish and Italian yields have gotten down around 4.5%  – historically a common yield.    Portugal is over 6%, and Greece still over 11%, meaning that markets still aren’t confident about Greece despite the EU bailouts.  Clearly, though the sense of crisis is passing, the smart money is now on the Euro.

So why – why has the Euro proven so resilient and gotten so much support?   Simply, the Europeans realize that if the continent fractured between the wealthy core and poor fringe, it would harm everyone.  Greece, Spain and Portugal, late joiners of the then European Community  (EC), would see their progress towards modernizing their economies punctured.   The core countries would also suffer.  They’d lose markets in the fringe countries, and their currency — perhaps a contracted Euro – would appreciate so much that their exports would suffer.

If the Euro were to break up, the poor countries would do like Iceland did – allow a depreciation of the currency to effectively cut everyone’s pay by 50%.    But defaulting and inflating on the fringe would do severe damage to the core’s banking system, as they are heavily exposed to that debt.   So it’s in the core’s interest to make sure that doesn’t happen.

Some of called Merkel the "Abraham Lincoln" of Europe, keeping the EU together

Some of called Merkel the “Abraham Lincoln” of Europe, keeping the EU together

German Chancellor Angela Merkel, in demanding countries undertake austerity programs and reform their economic structures in exchange for bail outs, has been criticized as wanting to force everyone to have the German model economy.   Germany’s gaining control of Europe!   But the German model works – and it’s what Sweden and other northern European countries follow.  You base your economy on supporting production and having sound fiscal and monetary policies.

If Italy, Greece, Spain and Portugal aren’t forced to structurally adjust to the realities of 21st Century globalization, they’ll fall behind and might never recover.  If they do – as hard as the next few years will be – they could emerge with new economic structures in place to allow them to grow and have sustainable, productive economies.   That will be good for everyone.

What the skeptical commentators don’t get is that the European Union has developed a different notion of sovereignty, one that sees the destinies of the European states as linked.  That’s a different way of thinking, people aren’t just German or French, but also European.   Such a re-conception of sovereignty is incomplete and has pockets of opposition.  But as Merkel pushes the EU towards a model of fiscal union, with other states recognizing it is in their self-interest to follow, the European Union might once again defy skeptics and prove itself stronger than ever.

 

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More Europe for the Euro

The duo to not only save but also strengthen the Euro

The European Union has a history of turning crisis into opportunity.    At many times during its existence people thought that the project went too far, and that sovereignty would trump interdependence.   There was the ’empty chair’ crisis in 1966 when De Gaulle threatened to leave the EEC (then a group of six states) if they didn’t agree that all decisions have to be unanimous.

It was for many proof that sovereignty would always win.   Yet while they did let DeGaulle have his way on the issue he was angry about, the Luxembourg compromise that brought France back did not embrace DeGaulle’s principle of sovereignty first.   He accepted that because he was facing a revolt from below – the French people and French business thought DeGaulle was endangering France with his brinksmanship.   Already the eight year old organization had altered national interest.

Giscard and Schmidt ignited the “Franco-German engine” of European integration

In the seventies it appeared that the loss of the Bretton Woods system fixed exchange rates doomed the EC (now 9 states) to having no coherent monetary cooperation.   That could undermine the whole project, it was argued.   However, right when so-called Eurosclerosis was at its worst two people turned the situation around completely.   Former Finance Ministers and now leaders Helmut Schmidt of Germany and Valery Giscard d’Estaing of France developed the European Monetary System, the precursor to the common monetary policy.   Then when the Cold War ended many people thought the EC had run its course, that Germany would look eastward, and the organization might perish.

Instead German Chancellor Helmut Kohl and French President Francois Mitterrand forged the treaties that created the European Union, introducing a common currency and ultimately embracing rather than fearing the states of eastern Europe.    Now the EU has 27 members, 17 of them part of the Eurozone (states using the Euro as their currency).

In that backdrop the current crisis should be seen as a precursor to another step forward in bringing Europe together.   However, commentators in the US and Great Britain seem eager to declare the Euro dead or something that should have never been tried.   They are wrong.

The current crisis is serious, and shows some fundamental problems with Eurozone policy up until this point.   When it was originally planned, leaders knew that states could only support a common currency if they had similar fiscal policies.   That led to strict criteria demanding convergence on interest rates, inflation rates, budget deficits and total debt to GDP ratios.  If those criteria had been strictly enforced, there would be no crisis today.    Unfortunately, those criteria were loosened, often for political grounds.   In order to speed the spread of the Euro, economic dangers were discarded.

The problems began when the cost of unifying Germany turned out to be immense, causing Germany to violate the original criteria.    France also had an economic slowdown leading to a similar loosening of the rules.    They were the ones who needed to enforce discipline, and once they broke the rules it was hard to keep others in line.

They might have tried, but the bubble economy of the first decade of the 20th Century created an illusion that all was well.    Debt may be high, but the world economy was growing and investments were yielding considerable profit.  In that deluded atmosphere countries like Greece, Italy, Ireland, Spain and Portugal ignored the warning signs — and their problems were ignored by those in the EU who should have known better.

Even if France and Germany lead, Greece may not follow. Populist Alexis Tsipras could lead Greece a different direction should he emerge victorious on the 17th – but even he has to understand the consequences.

The southern states bring to the EU a different ethos than the northern European states.    Greece is a prime example.   The level of corruption and public sector employment is immense while the actual productive economy is small.   Getting into government is a way to make money and gain perks.   As their public sector boomed, it was funded via debt and risky investment schemes.    When the bubble burst in 2008, the problems were laid bare.

Yet its not just a problem for the south.   Someone had to finance that massive debt, after all — and those someones were predominately northern European banks and investors.     So a default on debt or economic collapse in the south would quickly spread all through the EU, bringing down German banks as quickly as Spanish ones.   The economic contraction could yield a depression that might spread far beyond Europe.   In short, the bubble delusion led northern Europeans to finance the southern European excesses, making them just as vulnerable.

The map is slightly out of date – Estonia joined the Eurozone last year (2011)

The problem is that the creators of the Euro were right at the start:  you can’t have monetary union without strict rules forcing fiscal policy coordination.   They were wrong that just setting criteria would be enough — criteria can be ditched, after all.

The solution is clear:  1)  Find ways to eliminate and/or pool the debt from the southern European states.   While this is often correctly decried in countries like Germany as a bailout of states with incompetent economic policies, not doing so could also bring down the financial sector of the big, rich, northern states.    Therefore, Germany and others have to bite the bullet and help pay for the corrupt folly from the south.   However, that also leads to 2) there needs to be a tighter set of rules and institutions to force rational fiscal policies on the southern European states.    Often decried as an ‘austerity’ that simply deepens the recession in the south, it’s a necessary step to a sustainable economy.   Adding to debt and spending more without restructuring those economies will simply make the problem worse.

So if Germany and states in the north have to pay more, states in the south have to give up a kind of easy money life style that allowed them to live excessively beyond their means for so long.  Tax evasion, early retirements, massively large public sectors and the like will have to give way to an economy built on productivity and work.

If it works, the restructuring will be good for everyone.   Southern states will start to have real rather than faux prosperity and develop their productive capacity.   Not only will this save banks in the north from massive loses due to defaults, but will also be an engine of eurozone growth.

The poor/corrupt/unproductive south is unsustainable in a 21st Century European Union.    The difficult but necessary transition they’re going through will ultimately end the rich/poor dichotomy between northern and southern Europe.    The Euro will emerge stronger, and a Europe with much better coordinated fiscal and banking policies (overseen by real institutions not just vague rules) would be a far better bet than leaving the national economies to follow their own idiosyncratic paths.

Merkel and Hollande know the stakes.   They know that they can join past Franco-German duos in turning a crisis that many thing will tear the EU apart to one that strengthens it and brings it together.   The negotiations won’t be easy, but given the history of the EU and the recognition that the era of fully sovereign independent states is over in Europe, I’m confident they will be able to accomplish the task and make the EU a model of how political economy in the era of globalizationn can be structured.

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What the French Election Means

We won’t know for sure the results from France until the second round of voting is completed on May 6, but Francois Hollande’s surprising win on the first round with 28.6% to 27.1% makes him the favorite on May 6th.

First, a bit about French Presidential elections.   They are held every five years and usually draw a variety of candidates. The election is only won on the first round if a candidate receives a majority of the vote: 50% plus 1.   Otherwise, the top two candidates hold a run off two weeks later.   Never has a sitting President actually not finished on top in the first ballot, though often with very low vote totals.   In 2002 an especially angry electorate gave the top candidate of the right, Jacques Chirac, only 19% of the vote and Socialist Lionel Jospin 16%.    The problem was that far right Jean-Marie LePen got 17%, thereby creating a meaningless run off.   The left couldn’t vote for a neo-fascist so they plugged their noses and voted for Chirac, who won with 83%.  Otherwise, the system has worked pretty well.

Marine LePen, daughter of Jean-Marie, focused on the traditional theme of the National Front: Fear.   Her combative tone against foreigners, Muslims, social change and France’s future helped her double the total for the neo-fascist party over her father’s 2007 numbers.  But National Front voters are fickle.   You might think that they’d go to Sarkozy, but historically about 40% stay with the conservative candidate, 30% sit out, and the rest go to the Socialist.   That’s because National Front voters hate foreigners but some have economic views more towards the left.

National Front leader Marine Le Pen

It’s possible that the large vote total for LePen will give Sarkozy a greater proportion than usual; if so, he could pull off a surprise.   It’s also possible that some people who prefer Sarkozy to Hollande might have voted for Hollande on the first round to send a message.   They also have two intense weeks of campaigning ahead.   Still, the odds now favor Hollande.

Sarkozy and his wife Carla Bruni-Sarkozy

In play is the very approach the EU takes to the Euro-crisis caused by weak economies in the south.    Led by German Chancellor Angela Merkel, the EU response has been to push for austerity from debt ridden countries.   The idea behind this is that debt is such a cancerous and pernicious force when it reaches levels over 100% of GDP, but no economy can be fixed without first reducing debt to GDP ratios and getting the budget under control.   Moreover, that’s the only way to protect the viability of the Euro.

It’s been a hard sell.   The economic impact of austerity has been profound in Greece, Spain and elsewhere; it’s led to an intensification of the recession.  That cuts revenues further and creates the danger of a downward spiral.

Enter Hollande.  He is of the school that says that when in recession austerity is not the proper approach.  The main goal is to get the economy growing again.   Austerity is how we responded to the Great Depression and it only made the depression deeper and longer.    He wants to revisit last year’s EU agreement and rethink the approach the EU is taking to dealing with the current crisis.

Hollande and his "companion" Valerie Trierweile - either way France will have an attractive "first lady"

Sarkozy’s camp is arguing that the Merkel-Sarkozy (Merkozy) agreement is necessary to save the Euro, and that a Hollande win will rattle capital markets and threaten another major crisis about the future of the Euro.  The hope is that while the French don’t like Sarkozy’s glitzy style and blame him for not finding a way out of the economic doldrums, they’ll fear Hollande will make things worse.

It gets complicated.   Many argue that Sarkozy and Merkel’s relationship is paramount, and that a Hollande victory would risk undercutting the Franco-German “engine” of the EU.   Others say that Sarkozy has given Germany the leadership role in Europe by bending to Merkel’s will and that Hollande would be a better heir to De Gaulle’s idea of grandeur and leadership for France.   He’d be a leftist foil to Merkel’s conservative economic bent.

Merkozy?

This isn’t just about Greece.  French debt is sitting at 90% of GDP and rising.   Many in France fear austerity to cut that debt will hinder growth.    Hollande does say debt must be cut, but also believes the economy needs to be stimulated.   His approach is less like Merkel’s and more like Obama’s — start with a stimulus, try to get the economy moving, and once growth has returned then cut.    But what if growth doesn’t return and you simply end up with more debt?

And for all the grumbling about Merkel’s austerity, the German economy has weathered this crisis better than most.   Indeed, northern Europe, particularly Scandinavia (if you drop Iceland) and Germany have fared better than others in the West.   German debt has also risen, they have an 80% debt to GDP ratio, but the Social Democrats on the left and Christian Democrats on the right agreed to a balanced budget amendment to their constitution and have focused on debt as the major problem.

Yet German success doesn’t prove that their approach is best.   They also did not cut regulations in the financial sector when so many others did, they kept their industrial base alive, and still have a strong current account surplus.   Germany’s fundamentals stayed strong, the French fundamentals are weaker, and Greece is fundamentally flawed.

So this election matters.   A Sarkozy re-election means continuing along the “Merkozy” path with the hope that her economic approach is right — cut debt, then rebuild growth with a stable Euro.   German leadership in the EU will continue, at least until this crisis passes.   If Hollande is elected there will be a vigorous debate about the German way on dealing with the crisis.   Countries like Greece and Italy will have hope that maybe their future isn’t a dramatic drop in their standard of living to pay back debt, but a looser approach designed to bring back growth.

No one knows what Hollande will really do or how Europe will react.  No one can be sure that Merkel’s approach is right, or if austerity is poison.    But this election will make a difference, and frankly, I’m not sure who I hope wins!   I like Merkel and think the German approach is pretty persausive.  But…if it’s wrong that could doom southern Europe and harm the EU overall…   Interesting times!

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Sarkozy and Merkel

Governments and central banks are doing all they can to prevent a devastating collapse of the Euro, which could potentially create panic in the US and a global economic meltdown right at a time when conditions have started to improve.    Can they succeed?

They say that every crisis holds an opportunity.   The key to avoiding collapse and coming up with a long term solution for the Eurozone is to expand and deepen European unity.   Rather than tearing the EU apart, this crisis could make it a more cohesive unit.   What doesn’t kill the EU, only makes it stronger.

So as markets worry about the potential of a real crisis should the Euro fail, Sarkozy and Merkel hold the key to the Euro’s future.  While we still think in terms of sovereign states, globalization has connected the financial system to such a degree that a Euro collapse could mean a dollar collapse.    Contagion from big banks in Europe can sweep through the US and even China and the third world.

Euroskeptics — those who opppose the EU and the effort to unify Europe — seem to be on the rise.   In polls national governments trying to save the EU find support dwindling as distinctly nationalist rhetoric takes over.   A lot of people look at this and say “see, the people are rejecting the EU, it’s going to fail.”   But that overlooks one important fact: EU supporters may be a minority in many countries, but they have money and power.   To borrow a phrase from OWS, the “1%” are adamantly behind the EU and the need to save the Euro.   Businesses and corporations would face higher costs and chaotic conditions should the Euro fail.

Even in democracies money talks.   The capitalist class, the elite, ‘big business’ — whatever you want to call them — are determined to save the Euro.   That’s why I’m convinced it will be saved.

On Friday Chancellor Merkel will address the German Bundestag a day after French President Sarkozy gave a speech calling for a “refounding of Europe” and promising that he and Merkel would meet Monday to develop a plan to expand qualified majority voting (making it easier to pass binding policies on all) and enhance coordination of fiscal policies.   It all looks like a well choreographed political dance.

Sarkozy takes the lead, something the Germans have almost always wanted the French to do.  The French like that role, and it softens perceptions that the Germans are dictating what to do to the rest of Europe.   Even 65 years after WWII Europeans are sensitive to that!    At the same time European Central Bank head Mario Draghi promised that if the political leaders could reach agreement, the ECB would take stronger action.   The ECB has been criticized for not doing enough, this signaled a potential change.

In the US, the Federal Reserve announced it was approving temporary dollar liquidity swap arrangements, essentially meaning that the US would loan money to European banks to help it through a potential crisis.   This does two things.  First, it buys time meaning that some kind of set back in European talks doesn’t mean disaster.   Second, it signals to the EU that the US is on board with making saving the Euro a priority.   This is not an act of charity — US banks and the US financial system would be devastated by a Euro collapse.

Dark blue states are in the 'Eurozone,' the other light blue states are in the EU, with year of membership noted. This map does not include Estonia in the Eurozone, though it joined this year

A lot of people have criticized the Eurozone for having monetary union before fiscal union.   How, people ask, can you have one monetary policy and 17 separate fiscal policies?   But while that question seems to imply that the monetary union was a bad idea, it could also be seen as a reason for the monetary union — the monetary union was meant to make coordinated fiscal policies a necessity.   Monetary union would lead to fiscal policies becoming more similar.

Indeed, the rules underlying the EMU were meant to enforce fiscal restraint — debt was to be below 60% of GDP and deficits no more than 3% of GDP.   These rules, however, got brushed aside both as Germany’s cost of unification created higher debt than would have been allowed (they’ve since passed a balanced budget amendment) and a recession in the 90s led to a softening of the rules.   When the boom of the bubble years came, Europeans like Americans got fooled into thinking the good times would last.   Efforts to promote fiscal discipline faded.    The imbalances grew rather than contracted and the result is a Eurozone crisis.

Thus it falls to Nicholas Sarkozy and Angela Merkel to continue the Franco-German engine of the EU.    This duo is not the first.   Konrad Adenauer and Charles De Gualle signed the Franco-German friendship treaty and worked hard in the early days to make the then “European Economic Community” of six nations a success, building a customs union by 1967.

In the seventies as the EU suffered oil shocks and sharply divergent monetary policies, Valery Giscard d’Estaing and Helmut Schmidt not only promoted very important institutional reform, but they set in place the European Monetary System that began the move to monetary union.  In fact, in the late eighties in retirement they publicly called for a push towards EMU, starting the discussions that would lead to Maastricht.

In the eighties and nineties a new duo, French Socialist Francois Mitterrand and German conservative Helmut Kohl worked tirelessly to make European union a reality, and were the most important actors behind the push to not only pass the Maastricht agreement but to persevere politically even when people in their own states doubted its wisdom.  Kohl was an especially committed and foresightful Europeanist, believing European stability required European union.

Each step of EU development has seen a strong Franco-German force behind the moves.    Now its time for Merkel and Sarkozy to join the Franco-German duets of the past to not only put forth a plan to rescue the Eurozone, but also to take this crisis and use it as an opportunity to move the Eu forward.   Are they up to the task?  I wouldn’t bet against them.

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Reports of the Euro’s Death are Premature

I started serious study of the European Union when it was the ten nation European Community back in 1982.   At that time, the EC was deep in crisis.  Britain was threatening to leave over how much it paid in compared to what it got back, divergent monetary policies were stalling efforts to create a stable exchange rate system, and even Ernst Haas whose ‘neo-functionalism’ was the driving theory behind European integration had labeled integration theory ‘obsolescent.’

At the time I took a course in Bologna, Italy, taught by Gianni Bonvicini on the politics of the West European integration. Bonvincini was strong proponent of integration, and told us that it was all but inevitable that Europe would develop a common currency.  He said European integration always moved in fits and starts, with existential crises causing critics to (sometimes gleefully) claim its demise.   For every two steps forward there was often a step back, but that success was far more likely than failure.

The EC survived that bout of “eurosclerosis” and by the early nineties goods and people could flow more freely than ever as borders became irrelevant — you could cross from Germany to France like one might from Maine to New Hampshire.   When the Cold War ended and barriers to international capital flows dramatically decreased, countries were compelled to adopt tighter monetary policies, thereby making the idea of a common currency feasible.   In December 1991 EC leaders signed the Maastricht treaty to create a common currency and rename the Community “the European Union.”  Although there were many times in the 90s people were certain that the Euro would never actually get off the ground, it was born in 1999 when  the European currencies became permanently fixed.

By that time the EU had 15 states, but only 11 were in the Eurozone.     France, Germany, Austria, Belgium, Finland, Luxembourg, the Netherlands and Ireland were clearly ready.   Spain and Portugal were questionable but overall had a good enough track record of economic improvement.     Italy really didn’t fulfill the criteria, but Prime Minister Romano Prodi’s economic austerity programs of the late 90s were seen as putting Italy on the right track, so it was accepted.

Three states opted out of the Eurozone: the UK, Sweden and Denmark.   A fourth was seen as not being ready:  Greece.  As the EU moved towards the issuance of actual coins and bills on January 1, 2002, the Greeks pressured the EU to bring them into the core group as well.   With only 10 million people their economy was small; any crisis in Greece could be handled.   On the other hand, Euro-imposed discipline might help improve the Greek economy and keep it open to outside investors who prefered Euros to Drachmas.    Ultimately, much to the chagrin of many economists and central bankers, the EU gave in — Greece was able to join in 2001.

Since then the Euro has expanded to many other countries: Malta, Estonia, Slovenia, Cyprus and Slovakia.   These countries have low debt and have done well in recovering from Communist rule.

Overall, the Euro has been a success, maintaining high value and becoming a true alternative to the dollar (even today the Euro trades at $1.37 per Euro, much higher than their original goal of a 1:1 valuation).    Alas, the crises in Greece and now Italy have led many to say “bye bye Euro,” believing that the experiment in monetary union is failing.

Don’t believe it.   The Europessimists of today sound much like those of the early 80s, yet I think Dr. Bonvicini’s claim that success is far more likely than failure still rings true.  The Euro will survive and eventually thrive again, just as the EU will continue to deepen regional integration, redefining the concept of sovereignty.

This doesn’t mean that there won’t be some dramatic moves.   There are rumors throughout Europe that German Chancellor Merkel and French President Sarkozy are talking about a smaller Eurozone, with a number of countries potentially being “kicked out.”    This is possible and while it would be called a “collapse of the Euro,” it actually might be necessary to save the Euro.

The reality is that the Euro itself has functioned and still functions very well as a common currency for most Eurozone members.   They would find it extremely expensive for the currency to somehow go away.   Businesses and banks would recoil at losing the Euro as they’d have to deal with a confusing world of diverse monetary policies and currency exchanges.    With the most powerful economic actors in Europe working to assure the Euro survives, it will.   Moreover, Merkel may not be as dedicated to Europe as Kohl was — but she’s pretty dedicated!

The problem is less the Euro than high debt rates in Italy and Greece.   That’s dragging down the Euro and also threatens the solvency of European banks.   The banks need to be recapitalized in order to protect the European financial system — that’s the case no matter what the currency.   It’s easier to do that with the Euro than with a set of local currencies.   States leaving the Eurozone (Greece, maybe Italy, Spain and Portugal as well) would face a very difficult economic reality.     It would be hard to get investors to commit to a state where currency values would be likely to plummet.   Even if they did default on their debt, the shock to their domestic economies would be immense.

Still, it would be the equivalent of a bankruptcy which would give the states the same chance to start over that bankruptcy gives an individual.   Overtime if they built a stronger more sustainable political and economic structure they could rejoin the Eurozone.   That might actually work better than trying to pursue expensive bailouts of deeply indebted economies.   The taxpayers would rescue their own banks rather than countries swimming in debt — but that might be an easier political sell.

Most people assume that if forced to leave the Eurozone states would simply go back to their domestic currencies.   But it’s possible to imagine a second Eurozone currency for countries “on probation.”  The benefit of this would be that the ECB could also set monetary policy for that currency, recognizing that inflation is perhaps an inevitable short term condition. The goal would be to ‘rejoin’ the Eurozone at some point, and fiscal plans could be developed to reconstruct these sick and in some ways unsustainable economies into ones that could function within the Eurozone.

I’m not sure how feasible a “Euro light” would be — what it would be called, or even if it truly could work as a common currency across the ‘problem states.’    In essence this would be a resurgence of a theory popular in the 90s for a “two speed Europe.”   The wealthier countries would increase integration and become more closely linked then they can now.   The problem states could be put on a strict leash, forced to follow strict guidelines if they want to rejoin the core.   In theory this could actually push integration forward and deepen it.    That would make this like past existential crises — what doesn’t kill the EU only makes it stronger!

There would be immense opposition to such a Franco-German plan, and the short term costs in those two core countries could be large (especially as trade would decline as ‘core country’ goods would become much more expensive in inflation riddled problem countries.)    Rather than this being the death of the Euro, this could be the crisis that the Euro inevitably must face if it is to emerge as a true long term global reserve currency.   And to those who predict that this will destroy the project of European integration, well, people have been predicting that about various crises for over fifty years.   So far they’ve been wrong every time.

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Modell Deutschland

The term “Modell Deutschland” was coined by the Social Democratic party for the 1976 election campaign: Germany as a model economy.   Europe and the US had endured a recession in 1974-75 that had a whiff of the deeper recession that would come in the early 80s — stagflation, an oil shock, and high unemployment.   In Germany, however, Helmut Schmidt’s Social Democratic party managed to handle the recession with aplomb.   Germany fared well, and in fact the Social Democrats expanded worker co-determination (giving workers a say in how companies are run, and seats on the boards of directors).

Based on this New York Times piece, the phrase still fits, this time with Angela Merkel’s Christian Democratic party.   Germany’s success so far in handling the recession even while paying the lions’ share of bailouts for Greece and Ireland is the envy of the industrialized world.   While Germans themselves grumble about the difficulties of the Euro and trying to keep the economy going during a global depression, they’ve managed to keep growth going and out perform most other countries.

Chancellor Angela Merkel (CDU – the right of center Christian Democratic Party) was in a “grand coalition” with the left-of-center Social Democrats when the crisis hit in 2008.   Together the two parties passed a balanced budget act, requiring the Bundestag and German Länder (states) to limit budget deficits to .35% of GDP by 2016 and to have them balanced by 2020.   There are exceptions in the case of national disasters and emergencies, but the point was clear: there is German consensus that debt has to remain under control.

Most economists are uncomfortable when debt to GDP ratios rise above 60%.   By that point increasing the debt does little to stimulate the economy (and actually becomes counter-productive when you get to about 100% of GDP) and creates long term damage.   After getting budgets under control by 2007, the recession pushed them back up over 70% of GDP.   Given that 60% is the proscribed (but ignored) Eurozone limit, the high debt level was embarrassing.    The Germans wanted to send a clear message that this was short term, with both the left and the right united in vowing to cut debt moving forward.

President Obama urged the Germans to pass a stimulus in 2009 to help get the European economy going.  Merkel, a physicist by profession, simply could not see the logic in Obama’s view.   While the US with the dollar as a global reserve currency and massive economic clout might be able to get away with debt to GDP ratios nearing 100% (though she had her doubts on that too), it would be reckless for Germany to take that approach.  Instead, after securing re-election and joining the FDP in a new center-right coalition, her government passed an austerity program at home, even as it had to pay to help the Greeks and Irish.   Merkel was hesitant to help (her hesitancy was criticized as making the situation worse), but it’s hard to tell your own citizens to take cuts while paying for countries that had little economic discipline.

Merkel’s program was what Obama would call balanced — revenue increases and spending cuts.   However, the Germans did things differently than the Americans.   First, they weren’t driven by ideology.    You didn’t have people condemning government “as the problem” and trying to blame either the right or the left for the situation, making it a political football.  They approached it rationally.

There is a recession.   The debt is too high.   Our demographics show our population is aging.   It is a part of Germany’s moral and ethical character to have a stable social welfare system that guarantees health care, helps the unemployed and assures that the elderly do not suffer.   It is essential for Germany to educate its children well in order to compete in the future.   How can we make reforms that allow us to adapt to the recession, cut debt, but not endanger our population and our social welfare system?

The answer, of course, was to look at their spending and determine where there were inefficiencies, what areas could be cut, and to set priorities.   Yes, a modern industrialized state without a quality social welfare system may be barbaric, but you can’t allow social welfare programs to remove incentives to work, to cost more than the people can afford, and undercut rather than support social solidarity.     Of course, cuts aren’t all it takes – when you’ve got debt, you also have to increase revenue, so taxes had to go up.   This also was done pragmatically — rather than just a “tax the rich” vs. “taxes or evil” debate, they had to figure out how to raise revenues in ways that didn’t hurt the economy or create inequities.

Tax increases are a less harmful way of reducing debt than spending cuts.   Spending cuts slow the economy more than a tax increase.    But too many taxes alongside wasteful spending creates a lose-lose situation.    These are not decisions for ideologues or political pontificators, they are decisions to be reached with a cool rational eye on the facts.

To be sure, Germany has advantages.   It does not have the gap between the rich and the poor that the US has.   While America’s middle class has had stagnant wages the last thirty years, all Germans have seen consistent income growth.   While the gap between the rich and and poor has been growing here, that hasn’t happened in Germany.  There are still people who are very rich, and there are poor people — and there are incentives to innovate, produce and invest.  But the power hasn’t shifted completely to the wealthy elite.    Strong labor unions especially assure that more equitable relations are maintained — business and labor have more a partnership than separate classes.   Germany proves that those who hate or demonize labor unions are misguided.

Germany also avoided the housing bubble, even if many of its banks invested in dubious CDOs.   Germany’s financial and economic sectors are heavily regulated, and therefore resist the kind of wild fiascos that engulfed Ireland, the US, Iceland, Spain and all the others who believed the 1990s myth that de-regulation was good and the ‘market gets it right.’   A good strong regulatory regime has helped Germany stay afloat.

Finally, Germany didn’t let it’s industrial sector die off in the last recession like the US did.  While the US went towards service industry and financials — producing less and consuming more through debt — Germany maintained a current account surplus (consumed less than it produced), and supported its industrial base.   That means that Germany lacks the huge imbalance the US suffers; the US has been living beyond its means, for the most part the Germans have not.

Germany has challenges — if you talk to Germans they’ll be vociferous in the need to still reform the health system, concern about the Euro, worries about high subsidies to industries, etc.   There are ideological differences between the left and right, though not usually pitched in the emotional ‘good vs. evil’ way of American politics.   There are vast differences between the US and Germany, and the US does do many things better.   Still, given the situation, there’s a lot we can learn from “model Germany.”

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