22 July 2015

Europe needs Britain in the EU to curb German dominance


For more than sixty years, German governments have sought a more European Germany. But now Angela Merkel’s administration wants a Germanic Europe. That has become increasingly clear since the bailout of Greece’s private creditors in 2010 sparked the crisis in the eurozone and thrust Germany, as creditor-in-chief, into the driving seat. And Berlin’s crushing of Greece, combined with the threat to force the country out of the euro, highlights how far a newly hegemonic Germany is willing to trample on others and undermine the system as a whole to achieve its narrow ends. While this is primarily a problem for the eurozone, it is also an issue for the European Union – not least Britain.

Ever since Germany’s reunification in 1990, Europeans have worried that it would come to dominate the continent. Assuaging those fears was one reason why the then German Chancellor, Helmut Kohl, and France’s president, François Mitterrand, agreed to merge their national currencies into the euro. Monetary union was also seen as a step towards a political one: European leaders thought that sharing a currency would bring their countries closer and ultimately result in some form of federal union.

Fast-forward twenty-five years: those federalist dreams are in tatters while Germany dominates the eurozone – and to a lesser extent the EU – like never before. Put to good ends, and proceeding with humility and broad support, German power need not be problematic. Were Berlin to throw its weight behind the completion of the single market in services, for instance, it could be a force for good. Regrettably, it is instead pursuing a harmful corporatist agenda. As I explained in CapX, the EU’s digital-single-market strategy is largely a protectionist sop for Germany’s digital flops.

Germany’s impact on the eurozone is particularly noxious. Its mercantilist obsession with running vast current-account surpluses destabilises the monetary union. Wages are suppressed to subsidise exports, while businesses are loath to invest in Germany’s hidebound economy, so they accumulate huge excess savings. That surplus cash fed German banks’ bad lending to southern Europe and Ireland in the bubble years, a big cause of the crisis.

Germany’s surplus has continued to balloon, reaching €233 billion in the year to May, approaching 8 per cent of GDP. But since it no longer exports capital to southern Europe, its depressed domestic demand exports deflation instead, sapping growth in the eurozone and making debts even harder to bear. Perversely, quantitative easing by the European Central Bank – launched to try to offset these deflationary pressures – is further inflating Germany’s surplus by weakening the euro.

All this also harms Britain. Weak eurozone demand stunts UK exports. So does the strength of sterling against the euro, which also inflates imports, widening Britain’s trade and current-account deficits.

Germany’s current-account surplus is the most dangerously destabilising imbalance in the eurozone – and arguably the world. Eurozone rules stipulate that Berlin must act to correct it, yet Germany has escaped censure by leaning on the European Commission. This refusal to adjust is a big impediment to resolving the crisis in the eurozone that Germany did so much to create.

More generally, the German-led crisis response is a disaster. The eurozone economy is still 1.5% smaller than seven years ago, while Britain’s has grown by 4.5%, Sweden’s by 7.2% and the United States’ by 9.4% over the same period. The unemployment rate in the eurozone is 11.1%, twice that in Britain and America.

Germany not only refuses to adjust; it has sought to pass the full costs of the crisis on to others. Having recklessly lent to Irish, Portuguese and Spanish banks, as well as to the Greek government, German banks should have suffered losses when those borrowers became insolvent. But Berlin insisted that European taxpayers bail them out – in breach of the Maastricht Treaty’s “no-bailout” rule, which stipulates that eurozone governments must not bail out their peers. This has left southern Europe struggling with crushing debts and has enabled Berlin to assert political control over the rest of the eurozone.

Berlin has demanded much greater controls over other countries’ budgets. These involve much more rigid, intrusive and democracy-constraining fiscal rules, as well as a fiscal compact written into national constitutions and enforceable through the European Court of Justice. Berlin thus has leverage not just over governments that have borrowed from it, but also over Paris and Rome. And since the supply chains for Germany’s subsidised exports now encompass its neighbours, these economic satellites also have an incentive to tow the German line. Thus Berlin generally gets its way.

Just look at the eurozone’s “banking union”. Germany’s Sparkassen, small savings banks which together have a €1 trillion balance sheet, are excluded from the ECB’s supervisory control. As for its rotten state-owned regional Landesbanks and fragile commercial behemoths such as Deutsche, the ECB has implausibly given them a clean bill of health.

Berlin is brutal in crushing dissent. In 2011, when Italy’s elected prime minister, Silvio Berlusconi, resisted the German line, Merkel orchestrated his removal and replacement by a technocrat. Ditto the then Greek prime minister, George Papandreou, for having the temerity to want to put the EU-IMF loan programme to Greece to a referendum. While Merkel could not deter the current Greek prime minister, Alexis Tsipras, from holding a referendum, she now wants to make Greeks suffer in order to crush Tsipras and deter others from defying her.

An insolvent Greece is thus condemned to being a depressed vassal state, with Berlin’s writ enforced on the ground by the Troika, which has the right to rewrite and veto Greek legislation at will. Greece would be better off leaving the euro, as I argued in CapX. But because Greeks are terrified of Grexit and remain attached to the euro as a badge of European modernity, they still want to stay – for now.

The EU Treaty makes no provision for euro exit. But by threatening to force Greece out, Germany has shredded the notion that the monetary union is irrevocable. That euro membership is now conditional on submission to Berlin transforms it into an extremely rigid and dangerously unstable fixed-exchange-rate regime. No wonder ECB President Mario Draghi is livid: Berlin has driven a coach and horses through his promise to do “whatever it takes” to hold the euro together.

Britain is not Greece. But there are lessons here for David Cameron. Like Tsipras, Cameron reckons he has leverage because Merkel wants to keep his country in the union – which she does, but only on her terms. Remember that Merkel has failed to come through for him before. More positively, fear of German dominance is a reason why other countries, including France, are keener than before to keep Britain in. Just don’t demand treaty change. European governments aren’t just wary of consulting disenchanted voters: they don’t want legal changes that entrench German hegemony.

Philippe Legrain, who was economic adviser to the President of the European Commission from 2011 to 2014, is a visiting senior fellow at the London School of Economics’ European Institute and the author of European Spring: Why Our Economies and Politics Are in a Mess — and How to Put Them Right.