Saturday 20 April 2019

Responsibility for flawed design of eurozone rests with Germany

The EU will be led out 
of the current mess 
by Germany or it will not be led at all, 
says Colm McCarthy

PLEDGE: German Chancellor Angela Merkel with Taoiseach Enda Kenny during an economic forum in Berlin last Thursday. She promised to assist in Ireland’s ‘impressive’ reform efforts, but didn’t list which reforms she found impressive. Photo: AP
PLEDGE: German Chancellor Angela Merkel with Taoiseach Enda Kenny during an economic forum in Berlin last Thursday. She promised to assist in Ireland’s ‘impressive’ reform efforts, but didn’t list which reforms she found impressive. Photo: AP
Colm McCarthy

Colm McCarthy

Germany has, by common agreement, had rather a good eurozone crisis. Output in Germany in 2013 was 4.2pc ahead of the figure for the pre-crisis year of 2007, which does not sound too exciting until it is compared with the other two large eurozone economies, France, where output grew just 0.6pc and Italy, where it fell 8.7pc.

For the 18-member eurozone as a whole, output in 2013 was 2pc below the figure six years earlier - the longest downturn since World War II. The debt-ridden peripheral countries have done uniformly badly - in Ireland, output in 2013 was down 8pc on the pre-crisis level; in Spain almost 6pc down; in Portugal almost 7pc and in Greece there has been a horrendous 24pc contraction.  Germany's debt and deficit numbers look much better and this relative outperformance has been accompanied by increasing influence in European decision-making.

But the sun has smiled on the Bundesrepublik in other ways too. In the decade before the bust, Germany accumulated a large international creditor position through running big annual balance of payments surpluses, becoming a sizeable net holder of foreign financial assets. A financial bust can be painful for creditors as asset values fall and borrowers default. This time round, the distribution of the losses from the bust has been creditor-friendly, particularly in Europe, as taxpayers in various countries were bailed in to protect domestic and foreign creditors of their failing financial companies.

The US government also rescued some Wall Street banks and insurers whose failure would have been costly to the German banks. If the worldwide financial crisis had been resolved through the distribution of losses to savers and investors, as in textbook capitalism, rather than to taxpayers in debtor countries, Germany would have taken a substantial hit. But the perception has somehow been cultivated among the German electorate that they have 'rescued' the peripheral eurozone countries, notwithstanding the bailout of unsecured bank creditors in Germany and elsewhere by 
peripheral country citizens. This perception has scared German politicians into paralysis in re-engineering the flawed and ill-designed common currency area. They have watered down and delayed proposals for the creation of a proper economic and monetary union. Ironically, the design flaws in EMU Mark I are largely Germany's fault: the European Central Bank in particular operates to a rule book based on the Bundesbank model, and it is no accident that its headquarters are in Frankfurt. Responsibility for joining the eurozone rests with the governments which chose that course, as does responsibility for loose macroeconomic management thereafter; responsibility for the flawed eurozone design rests largely with Germany. The flaws have been recognised by some German politicians but there has been no admission of authorship.

This makes it hard for people to endure lectures from German economists and politicians about fiscal rectitude, market discipline and 'reform' in peripheral countries. Germany wrote the rule book, has benefited therefrom and has resisted reform where it matters - that is reform of the flawed eurozone structures. Any meaningful reform would include market discipline (losses) for unsecured bank creditors, so the German memory loss looks self-serving to those who have compensated creditors for unwise investments in dud banks.

Enda Kenny's most recent visit to Berlin last Thursday produced further effusions of goodwill from Angela Merkel and her colleagues in Germany's CDU party. The Taoiseach addressed the CDU's economic council, earning the following bromide from the chancellor: "Our task in the coming years is to show people in Ireland that the difficult path they took was worth it", which is kind of hard to beat for sheer vacuity. According to the Irish Times, the chancellor pledged to assist in Ireland's 'impressive' reform efforts, without listing the reforms which she found impressive. Aside from raising taxes and cutting expenditure, most observers in Ireland find it difficult to discern much serious reform intent in the Government's performance to date. Perhaps Merkel regards fiscal tightening and reform as pretty much the same thing.

The secretariat of the European Parliament is seriously unimpressed with Germany's own progress in implementing reforms. A report released last week considers the implementation by eurozone countries of reforms recommended by the European Commission in 2011 and 2012 under the so-called European Semester process. Out of 32 recommendations addressed to Germany, just three have been implemented in full. Work is under way to deal with a further 12, while nothing at all has been done regarding 17 recommendations, over half the total. All countries to which recommendations were addressed (the list did not include Ireland, then under a Troika programme) have done poorly, but Germany is well down towards the back of the class, as is France. Areas in which Germany has done nothing include bank restructuring, the elimination of tax wedges which discourage employment, tax discrimination against second earners, educational reform, energy costs and the promotion of competition in the professions. That is to say, Germany has failed to implement reforms in areas where it seems to be advocating reform for others. Yesterday, a report on Ireland from the Bundestag's finance committee offered yet more free advice, including finger-wagging about bank supervision, a field in which Germany's own performance through the crisis has been less than stellar.

Before convicting Germany of a narrow and hypocritical pursuit of its own interests in dealing with the eurozone debacle, it is worth considering what reactions in this country might have been if the boot was on the other foot. Suppose for a moment that Ireland's economic policies had been cautious and careful over the decade leading up to the crisis and that the banks had stayed solvent. Suppose further that various southern-European countries had encountered serious trouble and were seeking assistance. It is not hard to imagine that populist Irish politicians would have shown no great concern for their plight, and would have offered lectures instead of help. This is pretty much what has happened in Finland, for example.

But Germany is not just a larger version of Finland and the relative decline of French influence means that the European Union will be led out of the current mess by Germany or it will not be 
led at all. The semi-detached approach adopted by the 
United Kingdom, consequent on its non-membership in the eurozone, has made this inevitable.

The problems of the European Union extend beyond the common currency mess but the construction of a durable and soundly based monetary union is the key task. Six years into the crisis, Germany's immunity from the downturn appears to have translated into a refusal to accept any responsibility for leading the reform effort.

In appealing for relief from odious bank-related debts from the European Union's rescue fund, appeals routinely deflected by that body's spokespersons, Ireland looks to be flogging a dead horse. Anyway, it appears to be the wrong horse. The rescue fund and its EU-level predecessors do not appear to have set out to impose improper costs on Ireland or to have strayed outside their legal mandate. The same cannot be said for the European Central Bank which, under Jean-Claude Trichet twice prevented Irish finance ministers from imposing haircuts on holders of unsecured bonds issued by bust banks, including banks already closed down. It is widely assumed that this policy enjoyed the support of the eurozone's largest members, France and Germany. Ireland's unfinished business over bank-related debt is with the ECB and not with the EU rescue fund.

The European sovereign-debt crisis has been averted for now, courtesy of the ECB's credible threat to support sovereign bonds directly in the secondary market. Borrowing costs for the troubled eurozone governments have declined sharply and there is plenty of happy talk about recovery and a peaceful exit from crisis.

There is not so much hard evidence of actual recovery, though. Debt levels remain hugely overstretched in the periphery and the prospect remains of a prolonged further period of stagnation. The rate of unemployment in Europe remains almost double the figure in the United States.

Most worryingly, there is no evidence of urgency about developing a macroeconomic strategy to accompany the common currency with which most of the EU countries have encumbered themselves.

After the Second Punic War, Rome imposed on Carthage a draconian peace, divesting it of its colonies and enforcing a permanent tribute to Rome. The current calm in Europe has all the appearance of a Carthaginian peace.

There was, inevitably, a Third Punic War.

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