From being an EU stalwart, Germany finds itself divided into supporters and sceptics, with long-serving chancellor Angela Merkel fighting to form a government that can keep the European project on track. Stefanie Linhardt reports.

Germany EU consensus

Germany is as divided as it has ever been on its European future. A country that since the inception of the EU has positioned itself at the heart of the project is now experiencing division about its future path – at a time when other countries are keen on reform.

The oft-quoted Franco-German axis within the EU has a new reform-savvy force in the west, in the form of French president Emmanuel Macron. He defeated far right presidential candidate Marine Le Pen in the final round of elections in May 2017, a run-off that resulted in a clear winner.

In September the German electorate also went to the polls – but the outcome was far less straightforward. For the first time in the history of the current constitution, some 12.6% of those who voted did so for a populist party clearly opposed to the EU and eurozone project – as was Ms Le Pen in France. But in Germany’s case, the share of the vote for Alternative für Deutschland (AfD) translated into 94 seats in the German Bundestag, making it the third largest party.

With Germany’s next government yet to be formed, the future of its position on eurozone reform is unclear and will be eagerly watched. Still, Mr Macron has pushed ahead with proposing his vision for the reform of the EU – and especially the eurozone – as has the European Commission, with its December presentation of the reform proposals to the economic and monetary union.

A new political landscape

After some 12 years with Angela Merkel at the helm of German politics, and three legislative periods during which her conservative Christian Democratic Union (CDU) party, together with the Bavarian sister party the Christian Social Union (CSU), formed coalitions with the Social Democrats (SPD) in 2005 and 2013, and the Free Democrats (FDP) in 2009, the 2017 parliamentary elections have not resulted in a clear majority.

While Ms Merkel’s CDU remains the largest force in parliament, the major parties, the CDU and the CSU as well as the SPD, suffered heavy losses of some 7.3%, 1.2% and 5.2% of the vote share, respectively. Not only did the AfD soak up some of the votes but also the FDP (10.7%), which did not reach the required 5% share of the vote threshold in the last elections and thus was not represented in the 2013 Bundestag.

“Some 25% of the members of the current German Bundestag represent views that are Euro-hostile, [as is the case with] AfD, or at least Eurosceptic [as to] how the EU is managed, [as is the case with] the FDP,” says Ralph Brinkhaus, deputy chairman of the‎ CDU/CSU parliamentary group. “When you add the Eurosceptic members within my parliamentary group, who have, for example, refused any additional support for Greece, almost one-third of the members in the Bundestag have a problem with what is going on in the EU.”

But does this reflect the view of German society? And what does it mean for the likely position of a new government?

Stalling talks

After the SPD’s categorical ‘no’ to another grand coalition between the SPD and Ms Merkel’s CDU/CSU as soon as both parties’ historically poor result in 2017’s election became clear, the Conservatives turned to talks with the FDP and Bündis 90/Die Grüne (the Greens).

But trying to find common ground between the strongly pro-European Greens, who won an 8.9% share of the vote, the eurosceptic FDP and the CDU/CSU, whose position is somewhere in-between, was always going to be a struggle and talks subsequently broke down.

Gerhard Schick, financial policy spokesman of the Green party parliamentary group, says the Greens “very much agree” with Mr Macron’s approach of thinking “in a process” of integration.

“At its end is a finance minister, not at the beginning, because a finance minister without a budget makes no sense,” he says, adding that the eurozone budget is an economic idea his party backs, as it supports the currency union through fiscal policy. “During the sounding talks with the CDU, CSU and FDP we always stressed that Mr Macron’s extended hand has to be reciprocated – but those talks unfortunately failed,” he says.

The Greens support a 'eurozone-plus budget', which has the members of the currency union at its core, which is at least part-financed through fighting tax avoidance and near zero-taxation of certain multi-national corporations through a common EU corporation tax, and is governed by a finance minister who is controlled by the European Parliament.

A lack of harmony

The FDP, meanwhile, is critical of centralised political decision-making in the form of a eurozone finance minister and believes that the responsibility for finances must lie with every member state and not in a common capacity.

“Even if there was a full harmonisation of all rules within the eurozone – tax, labour law, pensions, etc – deep differences in the productivity and in the economic capacities of the member states of the eurozone [would remain]”, says Florian Toncar, member of parliament and whip for the FDP. “The less competitive countries would lose the opportunity to become more competitive by developing more favourable laws. The mere centralisation of political power and money will not reduce the problems of the eurozone; probably quite the opposite.”

After the collapse in the talks between the CDU/CSU, the FDP and the Greens, the SPD have reluctantly been pushed back into the picture. Like the Greens, the SPD favours European integration, so much so that leader Martin Schulz called for a “United States of Europe” by 2025, ahead of starting conversations with the CDU/CSU – clearly setting out the party’s position on Europe.

“We Social Democrats are in favour of coordinated economic and fiscal policies in Europe, with the perspective of establishing a common economic government for the euro area,” says Johannes Kahrs, spokesperson for budgetary policy of the parliamentary group of the SPD.

He adds that this “government” should consist of members of the commission with respective areas of responsibility and should be led by a European economic and finance minister. “We are also for a common eurozone budget [which is] an important supplement to safeguard the stability of the currency union,” he adds.

Schäuble’s vision

The Conservatives’ perspective on that is a little different. While Mr Brinkhaus largely welcomes Mr Macron’s reform willingness, he does not see a need for a eurozone finance minister or a eurozone budget, as he says it would “create a two-tier EU”. He supports the conversion of the European Stability Mechanism (ESM) into a European Monetary Fund (EMF) as long as the EMF is clearly defined, independent and “not a tool of the European Commission”.

“The idea that, for example, the EMF supports member states in case of asymmetric shocks makes us worry that this could, in the medium-term, develop into a transfer instrument,” says Mr Brinkhaus. “We don’t want a transfer union.”

The idea of an extended role for the ESM is something former German finance minister Wolfgang Schäuble supported in his 'Non-paper for paving the way towards a stability union', which he presented before leaving the post to become president of the Bundestag.

In Mr Schäuble’s 'non-paper', he lays out the idea for a stronger ESM with resources for crisis prevention, gradually moving into examining country risks through taking charge of monitoring compliance with the stability and growth pact, as well as with the fiscal compact and European fiscal rules (currently a remit of the European Commission) – proposals that would require treaty changes. The new ESM mandate would come with a “predictable debt restructuring mechanism” for sovereigns.

Mr Schäuble’s proposals have found some support but also attracted a backlash across experts and parties. The Greens have criticised the shift of control over the stability and growth pact away from the commission, while the most likely partner in a new government, the SPD, has also stressed the importance of democratic legitimacy and control, and warns that “an enhanced ESM must not turn into a technocratic regulatory body without democratic legitimation”, according to Mr Kahrs. But also in the context of a eurozone budget, the SPD would like to introduce further democratic checks through a new structure formed in the European Parliament specifically for the eurozone.

Targeting debt

Steffen Kampeter, director general of the Confederation of German Employers’ Associations (BDA), speaks for Germany’s employers, grouped in 49 specialist federations and 14 regional associations. He believes the transformation of the ESM into a monetary fund “could encourage targeted reforms” in the member states.

“The proposed anchoring of the fiscal compact in EU law, which provides for a balanced budget, is correct and long overdue,” says Mr Kampeter. “Sound public finances are essential, as well as compliance with the Maastricht criteria across all EU member states, especially regarding the return of public debt ratios to 60% of gross domestic product [GDP], so something needs to happen.”

According to Eurostat, the average general gross government debt-to-GDP ratio across the euro area was at 89.1% at the end of June 2017. The only eurozone countries below 60% were Estonia, Latvia, Lithuania, Luxembourg, Malta, the Netherlands and Slovakia. Meanwhile Greece (175%), Italy (135%), Portugal (132%), Cyprus (108%) and Belgium (107%) have the highest ratios; Germany missed the target by six percentage points.

“We have a set of rules in the stability and growth pact; we have the procedures in competitiveness; we have the banking union rules; and I think it is natural and obvious that these rules need to be implemented… in a manner that they meet the objective,” Ludger Schuknecht, chief economist at the German federal finance ministry, told The Banker at the International Monetary Fund meeting in October 2017. “That means for the stability and growth pact that they lead to sound public finances [and] to debt that is sustainable. It is a natural prerequisite, if we want to take our citizens with us, that we need to start with implementing properly what we have agreed on.”

For many, the crux lies in the lax enforcement of the rules by the European Commission. Some say the commission has become too political. But whether or not an enhanced ESM could better enforce sound public finances continues to be debated.

Enforcing market responsibility

Clemens Fuest, president of the IFO Institute Leibniz Institute for Economic Research and professor of economics at Munich University, believes the whole process of requiring member states to adhere to budget rules is flawed and considers it “counterproductive” to rely exclusively on fiscal rules.

“Fiscal rules are useful, and they should be respected, but in the end countries [are sovereign and they] will decide themselves whether they will follow these rules or not,” he says. “The 3% deficit rule has been violated 168 times since the introduction of the euro. Germany violated it, almost every country [has], and there were no consequences. We should have learnt by now that these rules have their limits.”

Mr Fuest instead proposes a new form of subordinated government debt that would need to be raised to finance any budget deficit over the 3% limit – a proposal developed by the IFO Institute. These so-called accountability bonds would be junior liabilities, which could not be purchased by the European Central Bank (ECB) or held by banks without equity underpinning, and would lose their value if the country were to apply for an ESM programme.

“These accountability bonds would be an instrument that allows for market discipline but they are not an alternative to fiscal rules – they make the rules stronger,” says Mr Fuest. He would also like to introduce limitations on banks buying government bonds in the future, to support the de-risking of the banking sector and enhance responsibility of the market and sovereigns.

Another proposal for a market-based model comes from the German central bank. The Bundesbank suggests an automatic maturity extension for sovereign bonds by three years, for example, in case the government applies for an ESM programme.

“Investors have to perceive a more credible threat of losing money if they buy bonds from countries with unsound public finances,” says Andreas Dombret, a Bundesbank executive board member. “That would buy time to distinguish between illiquidity and insolvency and [keep] the private creditors of those government bonds on the hook. So they could still be impacted if later a restructuring became necessary.”

The bankruptcy conundrum

Yet both suggestions require the willingness of governments to acknowledge that states can default on their debt, may require financial support and may need to restructure some of their liabilities – a confession not all eurozone members are ready to make.

Still, Mr Fuest sees no way out. “We are in a currency union and it is a fact that governments can go bankrupt and they may end up in a situation where they can’t pay back their debt,” he says. “So either we accept restructuring of government debt or we say taxpayers from other countries will pay for it, which would be highly unfair.”

The BDA’s Mr Kampeter also supports an orderly insolvency procedure for sovereigns, as he sees it as an effective means to “stimulate sound public finances and avoid the need for debt cuts”.

The Association of German Banks, meanwhile, criticises sovereign debt restructuring mechanisms in its November 2017 paper on the future of the economic and monetary union. Reasons include the high level of legacy debt and changes this would require to banking regulation and capital requirements. The association instead suggests focusing on the effectiveness of collective action clauses, allowing for changes to the terms of a bond, if a certain percentage of bondholders agree. Since 2013, these have been standardised and included in the terms of all government bonds issued by EU member states.

On the issue of EMF governance, the banks agree with Mr Schäuble’s idea of giving ultimate control over the fund to the euro member states as the owners of the fund, and not the European Commission.

Solidarity and responsibility

Leading economic adviser Marcel Fratzscher, president of DIW Berlin (the German Institute for Economic Research) and professor of macroeconomics and finance at the Humboldt University of Berlin, notes that while opinions differ, the need to introduce both responsibility and solidarity along with any eurozone reform is a widely agreed position across Germany. “I believe we can reach the ‘grand bargain’ if countries make the necessary reforms and take responsibility for Europe by making sure they co-operate and stick to the rules,” he says. “We need a balance between the two.”

Christian Ossig, general manager and member of the board of directors of the Association of German Banks, believes many challenges in Europe are connected to stability. “To advance solidarity and responsibility, EU member states need to be ready to hand over sovereignty, and that is something we as the banking association are very open to,” he says. In its position paper, the association call for incentives for “greater economic convergence and international competitiveness” to “eliminate institutional weaknesses” in eurozone members and “stop them disregarding jointly agreed rules”.

The association is, ultimately, in favour of a eurozone budget and finance minister, but first suggests launching two eurozone facilities with clear appropriation: one for special emergencies, such as natural disasters or severe, asymmetric economic shocks; and a second to promote the structural reforms needed in member states.

Meanwhile, proposals by Mr Macron and the European Commission suggesting more integration find little support from Mario Ohoven, president of Germany’s Association for Small and Medium-sized Businesses. He sees the reform ideas as “attempts to mutualise the debt of the EU’s member states” as he believes this results in an avoidance of “necessary reforms in the EU’s southern member states”.

“I get the impression that Brussels and Paris are using Berlin’s silence due to the drawn-out process of government formation to ram expensive pegs into the ground at the expense of economically sound EU members,” says Mr Ohoven.

Indeed, as long as Germany continues to be led by a caretaker government, its ability to react to any reform suggestions remains minimal.

Where is the majority?

With political and societal positions spread widely, the question remains where the majority lies. Surveys such as Eurostat’s Eurobarometer, which assesses public opinion in the EU, show continuing support for certain aspects of the European project.

In a survey conducted in early 2017, some 82% of German respondents said they felt like an EU citizen and the same percentage said they were in favour of a European economic and monetary union with the euro as a single currency. But it is clear that German savers are strongly displeased by the ECB’s ultra-low interest rates and would like an end to its loose monetary policy.

The result is that September’s elections have resulted in a polarised Bundestag. Its composition “will change politics just as UKIP changed the UK”, says Mr Brinkhaus, adding that he very strongly believes in the European project, and there is no alternative. “But we would like to ask Brussels to take some consideration for the sensitivities of the German population.”

Mr Fratzscher cautions that Germany has “always been one of the most pro-European countries in all of Europe” but it has “started turning inwards”. He believes the “increase in populism and nationalism”, also evident in other European countries, “will be the number one priority for the next German government”. “I hope that the next government will realise that this is a unique window of opportunity with Mr Macron having reached out to Germany and that it will need to react,” he says. “A French-German consensus is an important first step.”

The European debate will continue, but Germany faces a great struggle to bring its population and parties together and agree on a common European path that satisfies pro-Europeans and Eurosceptics alike. Should Ms Merkel remain the leader of the next government, the coming four years could well prove to be the most challenging of her chancellorship.


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