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Tuesday, December 20, 2011

What does Germany want (and why she can’t have it)?

Economists and indeed the general public are increasingly mystified by the actions and words of the German government. On the one hand, Chancellor Merkel spars no pains in reiterating her commitment to the Eurozone and her willingness to go the distance to restore its integrity and creditworthiness. On the other, her government and the Bundesbank have systematically vetoed all policy measures proposed by reputable economists to accomplish this end: Eurobonds, core-country wage/consumption increases, a credible commitment by the European Central Bank to backstop the sovereign debt of Italy and Spain. Instead they have used the fairy tale of “fiscal irresponsibility” (at best true only of Greece) to railroad austerity and a bogus “fiscal union” onto the rest of the Eurozone.

I am not alone in having proposed a viable nondeflationary and export-neutral alternative in my 19 January NYT op-ed. Such prominent commentators as Paul Krugman in the New York Times and Martin Wolf in the Financial Times have also debunked the fiscal irresponsibility myth (which is beginning to acquire the status of the 21st century’s “Dolchstosslegende”/”stab-in-the-back legend” of World War I vintage) and advanced similar policy prescriptions. So why has the German government been intransigent to the point of undermining its country’s own seeming self-interest?

I can see three alternative explanations, none entirely convincing, which question to varying degrees whether we are dealing with a modern “ruling elite” with a minimum of historical consciousness and economic savvy.
  1. German, and indeed many EZ and ECB leaders, simply do not get it: they lack the most basic understanding of the theory of effective demand, the cascading dynamics of bank runs and crises of confidence, and indeed their own economic history. They are still obsessed with the hyperinflation of 1923 but have completely forgotten the more important lesson from the disastrous 1931 austerity program of the ill-fated Brüning government. While the former wiped out the savings of the middle class, it also erased the nonredeemable German domestic war debt (but not the reparations) from the lost war. It was definitively ended not by austerity but by a currency reform that quickly returned the country to growth until the world crisis of 1929. The latter, however, only exacerbated the 1929 crisis, leading to mass unemployment and the social unrest that actually led to the rise of the Nazis, and did not even accomplish its ostensible but irrelevant justification: the rescinding of reparations. Instead, we hear the Bundesbank’s Jens Weidmann and German Economic Council Chairman Wolfgang Franz’s recurrent mantra that ECB intervention would be a central bank “cardinal sin.”

  2.  The “hidden agenda” or “Prussian designs” theories of such informed commentators as former EU official Bernard Connolly and international affairs analyst Tony Corn. Connolly argues that a Eurocratic Franco-German cabal has deliberately and surreptitiously imposed an ultimately undemocratic and economically dysfunctional currency union on the other EZ states to further its somewhat obscure political ambitions. And in fact five EZ governments have already fallen as a result of the Euro crisis, of which two (Greece and Italy) are now being ruled by unelected ‘technocratic’ (or as Paul Krugman puts it, ‘delusional’) interim cabinets. Corn, in contrast, sees the plot as entirely German, in the tradition of Bismarck’s Prussia, leveraging a customs union into de facto German hegemony. And the Franco-German partnership? “To the extent that the German-French tandem remains today the engine of European integration, Germany is now squarely in the rider’s saddle, while France - to use a Bismarckian metaphor - has to content itself with the role of the horse.”

    Whether one believes in the Connolly and Corn hidden agendas or not, many of their predictions have come to pass: undisputed German hegemony, limitations on democracy and national sovereignty, the rise of xenophobic and racist populist parties and an increasingly nationalist atmosphere in the press and political discourse.

    But is it plausible that a ruling elite would consciously jeopardize the economic well-being of its people to such an extent solely to further some hidden political ambitions? It would not be unprecedented historically, but in an era of democratic elections, a free press and an informed if anxious public it seems like a risky strategy with a rather ambiguous understanding of self-interest. Still, the second Bush administration got away for years with pulling the wool over the American electorate’s eyes over the Iraq invasion, in the pursuit of some elite’s understanding of its self-interest.

  3. The economic competition at a global level thesis. Instead of rebalancing the Eurozone internally without triggering deflation, while maintaining its export competitiveness unchanged, Germany has adopted a different perspective on the role of its EU partners that already proved successful in meeting the challenge of the low-wage, post-communist Eastern European countries after they joined the EU in the first decade of this century. By astutely integrating them into its supply chain, Germany not only did not suffer the loss of manufacturing employment the US has experienced through outsourcing and the ‘hollow’ corporation, it actually boosted its share in world exports and achieved export surpluses second only to China’s. Germany managed to combine its traditional strengths in advanced producer goods and high-end automobiles with low-cost suppliers from low-wage Eastern Europe. At the same time, it benefited from a lower external exchange rate and a consumption boom in the Eurozone periphery due to the Euro and the CDO-like magic of Eurozone interest rate convergence to the undiminished low German level. While the 2000 Lisbon Agenda called for the EU to become the most competitive knowledge-based economy in the world by 2010, this has been an abject failure, with R&D intensity only rising to 1.9% instead of the projected 3% of EU GDP. And with the bursting of the peripheral bubble in 2008, German industry no longer sees the field of battle as primarily within the EU, but rather with China on a world stage. As China moves up the technological value-added ladder, German competitiveness can only be maintained by harnessing all of the EU into its supply chain as low-wage producers, since there is only so much productivity growth and innovation that can still be wrung from its mature economy (the plight of solar panel manufacturers is a case in point). The race to the bottom is on to counter the low-wage Chinese juggernaut. The question is now who can most intensely exploit its migrant/Eurozone periphery workers, China or Germany?
From this global perspective, it is understandable that Germany does not want to jeopardize its favorable borrowing status by mutualizing Eurozone sovereign debt, nor shell out transfer payments and bailouts to keep its partners on the listing Euro boat from going under. Nor will a rebalancing of the Eurozone that rights the ship by increasing German wages, while just keeping German export competitiveness constant, be enough. German needs to increase its export competitiveness at all costs in the face of the Chinese challenge, without a Eurozone reform to weigh it down.

The only drawback of this strategy is that it will not work. Germany cannot have it both ways - the center of a web of low-cost labor feeding its potent export industries (Merkel’s marathon project requiring an endurance of years), while refusing to bear the costs of leadership in a functioning currency zone and true fiscal union in the here and now. And the attempt to drive down Eurozone periphery wages has only unleashed a devastating debt-deflation spiral, apparently to the surprise of EU and IMF economists alike.

The markets will deliver the verdict on this failing in a matter of days in the form of Eurozone cardiac arrest, before the grand German program can get off the ground. One can only hope that the failure of German leadership is not just blamed on the ‘usual suspects’ (take your pick of international speculators, hedge funds, rating agencies, lazy Greeks, Italians, etc., world Jewry, Muslim immigrants ...).

[A version of this post was submitted to the New York Times as an op-ed on Dec. 15.]


  1. Aside from grandstanding about what "Germany" wants, as if Germany was a monolithic entity and as if even the ruling parties were a unified block as to their ideas and intentions, there are a whole lot of other howlers in this article.

    The author tries to construct three possible explanations cooked together half from the tabloids, half possibly from his own prejudice. Ironically, he completely overlooks the actual internal dynamics of German politics in favor of some conspiracy theories.

    The most fundamental motivations for the members of a government - namely holding on to the power they hold - and what it takes to achieve that are completely ignored. No word that we have one coalition partner holding on for dear life and another one who is internally split about all the issues the author tries to make his readers believe Germany is actually monolithic on.

    It is funny that the author tries to warn against blaming "the usual suspects" in the end when essentially, that's all he does. Finding a scapegoat and then concocting some reasons why they are the bad guys.

    1. hydroxide is quite right that historians and social scientists have to be very careful in constructing collective entities like "Germany", "the German government", "ruling class", "elites", etc., and ascribing unitary interests and strategies to them (I won't comment on the invective). Nevertheless, at the end of the day the German government does exist and implements policies that reflect the interests of some individuals, groups, lobbies, electorates, etc., whether they share the same interests and agree about that policy or not. In the context of the Euro crisis it is clear that the German government has been playing a central role in the management of the crisis, for better or worse.

      Thus we are confronted with the problem of explaining that policy, and in particular, if it is the "rational" reflection of some interpretation of somebody's "interests,", which is what I attempt in this post.

      hydroxide proposes what he considers a simpler alternative explanation: that the present ruling coalition simply wants to hold on to power. While he/she is certainly right that this is almost always an immediate goal of elected parliamentary governments, that does not strike me as a very satisfactory explanation of the current government's behavior, for the following reasons:

      1. Merkel deliberately delayed the first Greek bailout in 2010 to pander to the electorate in North Rhein-Westphalia. Her party, the CDU, nevertheless lost power in that election, after which she reversed her implicit course and supported a bailout for Greece after all, something any informed person would have expected her to do. The net result was an expensive and politically unsettling delay in the bailout, the loss of face, and the loss of the election. Her subsequent vacillation between populist condemnation of Greeks à la Bildzeitung as lazy and profligate, and reiterated support for a Euro rescue, is the kind of inconsistent politic maneuvering that usually leads to a government's fall. Her coalition partner FDP's call for an ejection of Greece from the Eurozone has not made things better. Her government remains in power because there is no credible alternative, not because it is particularly credible with the electorate.

      2. While I do not have a "smoking gun" in the form of a clearly formulated policy statement of some members of the German economic "elite" (meaning export industry, finance, and the Bundesbank), see Bundesbank president Jens Weidmann's statement in an interview with the Financial Times ( other Eurozone countries need to undergo the same labour market reforms Germany had undertaken (i.e., lower their wages). German policy at the end of the day, abstracted from electoral posturing, has been remarkably consistent with this position. I do not see another way to explain German policy rationally short of calling it self-defeatingly inexplicable and pandering.

      The idea that the "conspiracy" explanations (i.e, due to Connolly and Corn - I do not consider my alternative a conspiracy so much as normal geostrategic political thinking) are from tabloids is based on ignorance. Connolly was featured in a front-page article in the New York Times, and Corn's piece was published in the Hoover Institution's Small Wars Journal. Corn has subsequently published a feature in the Frankfurter Allgemeine Zeitung very similar in spirit to my own post, also identifying competition with China as the overriding consideration (see

    2. PS to last reply: I'm somewhat taken aback that an intelligent reader like hydroxide would interpret my warning against blaming "the usual suspects" as itself a form of blaming the usual suspects. Of course I'm just blaming the current German government and whatever "ruling class" and electorate it thinks it represents.

      I guess I should be more careful in the future in my use of sarcasm.

  2. Germany vetoed all of those proposels because they are based on mathematical models of the world that are contested within economic department. Moreover the proposals are in contradiction to historical evidence:

    A) In all federal countries with stable finances and succesfull economies the states constituting said federal country _do_not_ grant each other's debt (e.g. the U.S.) or there are loads of regulations to ensure states do not spend too much (Germany). The former solution seems to be most unpopular in the US and in countries with financial problems. The later solution is hampered by other countries' willingness to introduce regulations that mirrior the German set up. The third solution, popular around the world and named "Germany pays without asking" or "free riding" in Germany and "Eurobonds" elsewhere is not an option to young Germans who have no feelings of guilt.
    -Core country wage increases are as silly a proposal as you can make. First, core countries are no centrally planned economy and it is for good reason enshrined in constitutions that wages are bargained for by employers and employees. Second, higher German wages mean higher prices for German goods. This means that German products will be replaced by Asian products all over the world. Remember that Asia already has the abality to fill the void left by Germany whereas Southern Europe needs decades to develope these abilities. It follows that not only will Southern European accounts rebalance against Germany's, but Europe as a whole is going to have a deep deficit with the rest of the world if German wages increase relative to other countries. This is no better than the situation we are in now. Europe as a whole willl be poorer rather than richer. What is really necessary is that Southern Europe gains competitiveness against Asia - a feat that is not in German hands.

    C)A credible commitment by the ECB to backstop Italy and Spain means in the end a commitment of Germany to backstop those countries because (1) Eurozone countries are obliged to rebalance the ECB should capital run thin and (2) for Italy, Spain and others to rebalance these accounts does not make sense if the EĆB is supposed to be their backstop rather than vice versa and (3) printing money in order to avoid the need for German capital in the ECB system has always produced either bubbles and inequality (the US after 09/11) or inflation (the seventies) or an eternally stagnant economy without the will to reform (Japan). Moreover it is well known that inflation harms (mostly German) owners of savings and is a boon to (mostly Southern European) debtors and you cannot ask a democratic government to act against the interests of its poeple. Indeed, you do not do so for every country but Germany, showing that you are prejudiced aggainst us.

    D) You confound cause and effect if you suggest that Germany railroads austerity on other nations. Germany accepted French wishes to introduce a common currency against the will of the Bundesbank. WIthout said Euro, Southern European countries would simply devalue their currencies and I do not remember that this was all that much of a problem for Germany at the time.

    E) The US, Great, Britain and southern European countries suggest with great effect solutions that are in _their_ interest. Germany merely protects its own interests by not following these proposals and does not tell other countries what to do: German talk of austerity started later than proposals that Germany pay for pretty much everything, not before Eurobonds and other proposals were made. You are initiating moralizing not us.