Germany is in a tough spot. On the one hand, the country's recent roaring growth figures have validated its export-led growth strategy and claims of helping to sustain the eurozone recovery. But Germany's recent economic success has also fueled anger among German citizens who feel the country’s overall gains have not hit home. European countries such as France, meanwhile, view Germany’s outperformance as proof that the country’s export glut is exacerbating economic imbalances within the eurozone while the United States is keen to see Germany set aside plans for fiscal tightening in favor of stimulus spending to spur global demand.
If German Chancellor Angela Merkel sees any reason to change course, she has little hope of making the adjustment. In pandering to public ire over the Greek crisis and demanding harsh austerity measures for Greece and other eurozone countries, Merkel forced her government into an irreversible and misguided stance on Germany's fiscal needs and its role in reviving the eurozone.
Merkel's iron will on fiscal austerity stems in part from short-sighted politics. After facing sharp criticism for mismanaging her coalition’s internal divisions and waffling over the Greek and eurozone debt crisis, Merkel would only appear weaker if she backed away from calls for German fiscal discipline now. Her center-right coalition is losing ground in the runup to the country's state elections next year, and Christian Democrats appear especially in danger of losing control of the conservative southern bastian of Baden-Wuertemberg, after an already crippling defeat in North Rhine-Westphalia. "People understand that when countries get over-indebted the stability of the currency is at risk," Merkel's budget spokesman recently said.
Focusing on debt and currency risks may conjure the sort of fear that fuels electoral victories. But short-term fiscal austerity will not fix the country's deep-seated economic woes. By dragging down the eurozone, it may only make Germany's situation worse.
German reunification in the 1990s left the country quick to associate ill-conceived monetary unions with high public debt, currency volatility and tax hikes. East Germany's adoption of the Deutsche Mark at an overvalued exchange rate prompted a sharp appreciation of the currency and brought the economy to a virtual standstill. The East’s heavy public and private sector debt—which became part of the federal budget—put major strain on the country’s public finances. Overall, government debt rose from nearly 50 percent of GDP in 1989 to 60 percent in 1994. To fortify the union and revive the economy, the government poured massive subsidies into indebted East German enterprises and granted tax breaks on housing construction to bring East German living standards in line with the West. Taxpayers bore the brunt of these costs, with little social improvement to show for it. To tackle the country's burgeoning debt problem, the tight-belted Bundesbank launched a fiscal austerity campaign that many considered the backbone of Germany's recovery.
But there are key differences between Germany's situation now versus twenty years ago. First, while many argue monetary integration in the 1990s burdened the German economy, today Germany's economy has benefitted—not suffered—from its eurozone ties. The weakened euro has only strengthened the country's export-led growth.
Second, the German government is not in danger of a debt-induced rise in borrowing costs any time soon. On the contrary, its stronger economy has driven spreads on German government bonds to near record lows, even as borrowing costs elsewhere in the eurozone—Italy, Portugal, Spain—have reached all-time highs. These discrepencies are fueling eurozone imbalances since higher borrowing costs in low-growth countries mean higher business costs for exporters struggling to compete with Germany. As part of the European Monetary Union, these countries also cannot resort to devaluing their exchange rate. They are instead stuck with a currency value that strengthens Germany’s economic standing at their expense.
But that is a sacrifice which eurozone countries made to enter the monetary union. To complement that sacrifice, the German government has its obligations, too. In a system that lacks adjustable exchange rates, member countries agree to an inflation target, which implies wage levels that rise relative to productivity gains. In tightening its grip on labor costs, (German labor costs have declined over the past decade relative to increases in other European countries), Germany overlooked this obligation, driving up growth while suppressing Germans’ abilities to consume. German private consumption has risen only 21 percent since German reunification, compared to 71 percent in the United States over the same period.
As German economist Heiner Flassbeck argues, this “wage dumping” strategy has led to Germany's grave misconception of the monetary union's meaning, the drivers of German economic growth, and the burdens of EU membership. It is no wonder then that hardworking Germans—suffering from deep insecurity about low wages, paltry social benefits, and job insecurity—are evermore skeptical of their debt-riddled eurozone neighbors.
Had Merkel explained these dynamics when the Greek debt crisis hit, her government may have found room to discuss needed German rebalancing. Instead, the government has merely played up the repercussions of Greece-like profligacy, trapping itself in a political dialogue that perpetuates Germany's export dependence and weakens the eurozone's chances of survival.
Roya Wolverson - Staff writer on economics at the Council on Foreign Relations in New York. Previously she worked as a financial reporter for the Wall Street Journal's SmartMoney Magazine.
