Germany: On Its Own or in the Middle of Europe?

Foreign Policy: Lesson Learned

Post euro crisis Germany is starting to learn the lesson, which is that economic power and international responsibility belong together. At a moment in time where several foreign policy debates are heavily influencing German public opinion—from “Grexit” to Brexit” to Maidan or TTIP, which all have substantial strategic components, demonstrating the intertwinement, not to say dependency of Germany on its European and international environment—German political elites are currently intensively trying to get across a pedagogical message that Germany cannot remain an economic giant dominating the eurozone, while staying more or less absent from the international arena in more strategic terms. In other words, Germany, since a year or so, has been awakening from its “big Switzerland” dream.

The country has been widely criticized in recent years about defaulting in the international policy arena: its abstention for example in the case of the UN humanitarian mission to Libya in 2011 triggered an outburst of anger among its peer partners within NATO and the EU, and the same accounts for its reluctant and weak support of the French-led mission in Mali 2013, to just quote two examples. At the same time, Germany had been criticized for expanding arms export to critical countries, e.g. Saudi-Arabia, for dominating the European-Chinese relationship by accounting for some 50% of the overall EU-Chinese exports, or for being too complaisant with Russia, being driven by its own interests in energy policy. The widely spread reproach was towards German mercantilism, which is putting export interests first, largely behind strategic concerns, and this not being always in the overall interest of the EU. In consequence, for years there was a discussion about German hegemony within Europe, unfolding in two arenas: a dominant position in the euro governance and a pivotal position for the foreign policy of the EU, both not always being congruent with the political or strategic interest of its European peers.

This reproach from its European partners came at a moment where the Germany’s public consensus on foreign policy stance was crumbling, as if the country lost its foreign policy compass. Traditional paradigms of Germany’s foreign policy orientation, e.g. its historical transatlantic orientation, were being shaken up under pressure: the NSA scandal and a largely hostile public opinion to the TTIP agreement contributed, in more recent months, to a new anti-American sentiment in German public and media, whereas the sympathies for Putin and Russia grew in parallel. The new buzzword in German language was the one of Putin-Versteher (people who understand Putin) and who consequently, in opposition to many influential circles in the US, were not eager to make out of the Russian annexation of Crimea a case for huge political reaction, let alone a military one.

With respect to the lasting Ukrainian-Russian conflict, Germany thus deployed large diplomatic and political energy to negotiate a solution by engaging in economic sanctions and mastering a successful balance on both the position within the EU and the NATO, paving the way, together with France, to the Minsk agreement. In a way, Germany here demonstrated European leadership at its best. This pivotal German role in the Russian-Ukrainian crisis and its quite successful management is a proof that Germany has understood the lesson that it actively needs to lead the EU. In order to do that, it is important to note, Germany went back to its most important tool with the Minsk agreement: the Franco-German engine.

In foreign policy, Germany is thus back on stage again. It does have a foreign policy design beyond mercantilism, it is redefining its strategic interests embedded in Europe and NATO, and it is putting the elements of it into place. For the first time, the German defense spending has been increased; Germany is also redressing problems of equipment of the Bundeswehr, it has quickly engaged in the Ebola crisis, and—despite problems with a partially hostile public opinion and the Pegida movement—it is quite vigorously engaging in better immigration policies. Germany has understood that her foreign environment from Russia to Syria and ISIS matters for her own prosperity, stability and security.

Germany has adapted to the challenge. For more than a year, foreign minister Frank-Walter Steinmeier has led a “Review Process” of the foreign ministry, including many stakeholders of the German foreign policy community. The goal was to make the ministry more malleable to react to international crises. Steinmeier reshuffled a couple of departments in order to make them better correspond to new crisis. The Review report just came out in February 2015. It stood at the end of a yearlong public discussion, in which Germany’s foreign policy community had tried hard to engage the country and its citizens in a debate on its role and perception in the world. The first was President Joachim Gauck, who launched this debate in a famous speech at the Munich security conference in January 2013 on Germany’s international responsibility, reiterated by a couple of subsequent speeches by foreign minister Frank-Walter Steinmeier or defense minister Ursula von der Leyen.

It is important to note that Germany had to cope with a historical alienation from taking responsibility in the international arena. Essentially, German authorities were told over the first 50 years after World War II to refrain from any power and engagement position in international policy. This has largely marked German political and academic elites. When, triggered through the euro crisis, came the emergence of a need for “German leadership,” the country was unprepared. In contrast to the US or the UK and even France, whose political elites are trained in a couple of distinguished universities or schools and given a broader historical and strategic education, Germany had no such political- strategic elite tradition.

Euro Governance: Still a Dialogue of the Deaf

With respect to the second biggest issue after the Ukrainian conflict, considering the acute “Grexit” danger and the structural flaws of the political economy of the eurozone, the German learning curb seems less visible. The arrival of the new-leftist Syriza government in Greece in January has led to serious bilateral confrontations and hardening of positions between Greece and Germany about the future euro crisis management and strategy. In a nutshell, Germany—and behind it the whole eurozone—refused to accept the “systemic question” that Syriza (and most prominently Greek finance minister Yanis Varoufakis) was trying to put on the table. Germany had to pay attention to a feeling of increasing impatience with respect to Greece in public opinion, which feels overstretched in solidarity with Greece. Being under huge pressure from the public and the media, and realizing the hardening stance of German economic elites on further Greek bailouts, indirect monetization of debts, or continued quantitative easing, let alone debt relief, Germany insisted on its austerity course and the need for structural reforms. In this debate on the appropriate euro governance strategy, German public opinion seems much less willing or inclined to integrate positions and opinions from its European neighbors, and to adapt own policy positions to the requests from the outside, for example when it comes to smoothing out its trade surplus or to increase internal demand. Its current economic success gives Germany bold leeway to think that its own economic policy course is right, that the other European countries should copy it; and that the German economic success relies on its own performance, often overlooking systemic structures of the eurozone, from whose Germany is largely benefitting, if not abusing them to its own interests.

The German rhetoric is therefore that the eurozone economy is finally on the mend, latching onto signs of life in Spain and Ireland as proof that their bitter prescription of fiscal consolidation and structural reforms has worked. Upon closer inspection, however, it becomes clear that the improvement is modest, probably temporary, and not the result of the policies promoted by Germany. True, according to some estimates, the eurozone economy may now be growing at an annual rate of 1.6%, up from 0.9% in the year, to the fourth quarter of 2014. Yet, with the eurozone economy 2% smaller than it was seven years ago, “recovery” does not feel like the right word—especially as the relief is unlikely to last.

Policymakers are counting on a more competitive currency to stimulate growth. But they are likely to be disappointed. With eurozone exports increasingly reliant on global supply chains, a cheaper currency provides less of a boost than before. Exporters may also choose to pocket any gains, rather than seek to expand market share. In 2014, exports from the eurozone amounted to nearly €2 trillion ($2.6 trillion at the time)— more than those from China. Given patchy global demand, rapid export growth will be difficult to achieve.

Germany is the one exception here, asymmetric to the rest of the eurozone and thus responsible for the unsolved question of trade-balances within the EU. In a subtle way, the eurozone, especially regions in its direct neighborhood, are subtly turned into a German workbench, with German industries benefitting from low labor workforce in a pan-European industrial value chain. In a way, Germany sucks these regions into its production structure. As cluster maps of industry show, the European economy is organized in transnational clusters, e.g. automobile industry in the German south, which is encompassing Slovenia, the Czech Republic and the north of Italy, with wide transnational supplier structures, yet all of them end in the German export statistics.

In any case, with exports accounting for only one-fifth of the eurozone’s €10 trillion economy, it is still unlikely to spur a strong recovery while domestic demand remains weak. According to the ECB’s model, the euro’s 10% depreciation over the past year (in real, trade-weighted terms) may lift growth this year by a mere 0.2%.

The benefits of quantitative easing are also likely to prove ephemeral. The decline in governments’ borrowing costs is unlikely to boost growth much, as European Union rules preclude fiscal expansion. Overall, the eurozone’s fiscal stance is set to be broadly neutral this year, according to the European Commission, albeit with further squeezes in Ireland, France, and Italy.

Spain is hardly an example of successful fiscal adjustment. On the contrary, its recovery coincided with the easing of the extreme austerity imposed in 2011–13, which has encouraged households to spend more, despite stagnant wages. Even so, its economy remains 5.7% smaller than it was seven years ago. A staggering 23.7% of Spaniards—and one in two young people— is unemployed, while many more have dropped out of the labor force altogether.

Meanwhile, Spain’s budget deficit was 5.7% of GDP last year, the highest in the EU. Its rapidly rising public debt is set to top 100% of GDP this year. As the country heads toward an election later this year, the European Commission has sanctioned the widening of its structural deficit. Rather than flourishing as a result of austerity, Spain is in many ways getting a free pass.

Nor does Ireland—the fastest-growing EU economy last year—confirm the appropriateness of Germany’s policy prescriptions. Ireland, after all, is a tiny highly open economy whose booming export sector is benefiting from existing strengths (including low business taxes, a skilled workforce, and a flexible economy) and favorable external conditions, especially the strong recovery of its main markets, the US and Britain. Even so, the economy is smaller than it was before the crisis, the unemployment rate is in double digits, domestic demand remains depressed, and the €64 billion bank-bailout bill unjustly imposed on 2.2 million Irish taxpayers still looms large.

The eurozone economy is set to do a bit better in 2015, but not because of the policies demanded by Germany. And it is likely to be a temporary bounce, not the start of a sustained recovery. To overcome its balance-sheet recession, the eurozone needs to tackle the deflationary drag of German mercantilism and overcome its embedded beggar-thy-neighbor pattern, where Germany is clearly the taker—at the detriment to its European fellow countries, and thus indirectly exporting unemployment. The structural flaws of eurozone mechanisms, which have played out in Germany’s favor, including a dominant and preferential position when it comes to shaping inflation targets for the eurozone (the southern European countries would currently benefit from a higher inflation), are as much responsible for the current German economic upturn as the uncontested vigor of German industry and its export strength.

When Germany did its structural adjustment at the beginning of the decade, it got help from the peripheral eurozone countries. The Hartz reforms significantly reduced labor costs and restored German competitiveness. At the same time, expansion in the peripheral countries, fuelled partly by German capital flows in search of investment opportunities, helped absorb German output when domestic conditions were subdued. As a result, the German current account balance turned positive around 2002 and reached more than 5 % in 2005, a level where it remained ever since. Export-led growth transformed Germany, which today enjoys near full employment and balanced budgets. But external surplus suggests that Germany’s competitiveness adjustment has gone too far and is especially detrimental to the peripheral euro countries. Germany has not earned its economic merits on its own; but still has it ears closed on these arguments and shows no real sign of adaptation to that criticism as it undoubtedly did in the foreign policy arena.