Economic Leadership in Europe

Angela Merkel - World Economic Forum Annual Meeting Davos 2009
Economic Leadership in Europe - David C. Unger


Europe urgently needs effective economic leadership to address its trade imbalances, shaky Eurobond markets, and diminishing trust in European integration. The European Union (EU)’s fiscal rules are neither strict enough nor comprehensive enough to hold the currency union together. The status quo is not sustainable. Already wobbly economies in Europe’s periphery face punishing, unaffordable interest rates as private creditors back away from their debt, and the European partners kick away successive chances to devise a comprehensive and feasible debt workout plan. Unfortunately, none of its present political leaders seems capable of meeting the challenge, in particular, German Chancellor Angela Merkel, the leader of the EU’s biggest economy, biggest exporter and biggest paymaster. Leaders overly focused on narrow perceptions of national advantage endanger the future of European economic integration and the benefits it has brought all member states.


Effective economic leadership in the European Union (EU) is an impossibility, and yet, a necessity. It is an impossibility because each of the EU’s 27 member countries is determined to retain as much national sovereignty as possible in matters of taxation, public spending, and bank and business regulation. It is a necessity because without it there can be no restoring the trust of nervous bond markets in the euro or even of disenchanted Europeans in the entire European integration project. rebuilding that trust is impossible in the absence of credible and coherent continental economic leadership that is politically acceptable to the voters of all EU states—or at least all euro-zone members— rich or poor, surplus or deficit, governed from the left or governed from the right.

In a world of globalized capital and labor markets, no country truly exercises full economic sovereignty; yet no government ever acknowledges this in public. Beyond globalization’s constraints, all 27 EU members have agreed to abide by the rules of the Single European Market and the decisions of the EU Competition Commissioner. furthermore, the 17 countries that use the euro have agreed to at least nominally abide by the fiscal benchmarks of the European Stability and growth Pact. Yet existing EU rules are, by design, far too weak to prevent the massive imbalances of trade, competitiveness, borrowing, and creditworthiness that have kept the EU and the euro in constant crisis for the past year and a half.

Redressing those imbalances is now a necessity if the euro, and the European integration process it underlies, are to survive. the alternative to survival would be very ugly—for the euro zone’s more robust economies like Germany and the Netherlands, as well as for its struggling ones like Greece and Ireland. Europe’s economic and financial integration has gone too far to disassemble without wide and lasting pain. the fact that Europe once managed satisfactorily without a common currency does not mean that it could do so today. History does not allow do-overs.

Solving the Euro Crisis?

Seventeen countries now use the euro—Estonia joined in January—and their prospects for paying their past, present, and future bills seem headed in 17 different directions. All sell bonds denominated in euros, but the interest rates each must pay vary widely, based on creditors’ varying perceptions of their risk of eventual default.

The European Central Bank could bring these rates more closely into line by issuing Eurobonds covering the whole euro zone. But the Bank’s directors, especially its German directors, oppose this. the newly established European financial Stability facility could help by lending to the most troubled economies. Germany, however, wants borrowers to first commit themselves to a wide range of made-in-Germany economic policies covering everything from wage indexing to retirement ages. Individual countries can do very little on their own to bring their interest rates into line, because as members of the euro, they are not free to devalue. Yet the high interest rate premiums some countries now have to pay could force one or more of them into default. that would hurt the credit of all euro users, put pressure on the defaulting country to abandon the common currency and on the other euro members to bail it out.

The official requirements for admission to the euro zone, as spelled out in the 1992 Maastricht treaty, set two absolute standards: 1. a deficit-to-GDP (gross domestic product) ratio below 3 percent, and 2. a debt-to-GDP ratio below 60 percent. It also set two relative standards: 1. inflation rates not more than 1.5 percentage points higher than the three lowest inflation countries in the zone, and 2. interest rates not more than 2 percentage points higher than the three best performing countries in terms of price stability. the absolute standards have since been redefined as “close to,” “moving in the right direction,” and “most of the time,” and the relative standards are vulnerable to external market shocks beyond the control of even the most prudently managed economies.

In 1997, the two absolute standards were incorporated into the European Stability and growth Pact and declared to be requirements for remaining in the euro zone. But again, this was more sovereignty than member nations really meant to yield. In 2005, at the insistence, interestingly, of Germany and France, these clear numerical criteria were deliberately relaxed and blended with various subjective tests (including allowance for higher deficits during recessions), which rendered them effectively unenforceable.

As of the end of 2010, the last year for which we have complete data, 10 of the then 16 members of the euro zone were out of compliance with either the debt or deficit requirement, and six had been out of compliance for at least three years. Remarkably, those six included Germany and France (and Austria, Belgium, Greece, and Italy), but did not include Ireland, Spain, or Portugal.

Germans want to believe another story—one of Teutonic bourgeois hard work and savings in contrast to Latin sloth and borrowing. This belief is stoked by nationalist tabloids like Bild and pandered to by nationalist politicians like Angela Merkel. And it is reinforced by Germany’s position as the EU’s largest economy and biggest financial contributor. Germany also, significantly, runs the EU’s largest export surplus, and its banks are the biggest creditors of wobbly banks in some of the euro zone’s weakest economies, to whom they lent imprudently in the boom years before 2008. There is a connection. Although the EU as a whole can run an export surplus, there is no realistic possibility for every member country to run a trade surplus since roughly two-thirds of total EU trade is with other EU members. Germany’s trade surpluses fueled Greece’s trade deficits, and German bank loans fueled the reckless Irish and Spanish mortgage lending that fed those countries’ housing bubbles.

The 2008 financial crisis punctured those housing bubbles, slashed tax receipts, and pushed several countries’ budget deficits well beyond the euro-zone convergence criteria. In particular, Greek, Irish, and Portuguese deficits swelled and made international lenders reluctant to roll over their bonds.

Chancellor Merkel initially said there would be no bailouts. Later, she said there could be bailouts, but only in exchange for growth-killing austerity. However, she then backed this statement with what turned out to be a bailout fund too small to impress credit markets. Subsequently, she and French president Nicolas Sarkozy said that after 2013, bailouts would be accompanied by debt write-downs, which is the same thing as telling lenders not to make long-term loans. And so on. Each grudging step forward is accompanied by conditions and declarations that undo the potential benefits. The sums committed get bigger, the austerity terms get tougher, and still there is no exit from the crisis.

A Vacancy in Economic Leadership

There can be no exit without effective European economic leadership. that leadership will have to come from one or more of Europe’s national leaders. Right now, there is no other kind of leader in the EU. The European Commission and Council are led by cautious bureaucrats who lack charisma and authority. To bridge Europe’s economic, political, and national divides, effective leaders will have to look beyond narrow, short-term national interests and summon the kind of supranational vision that guided Helmut kohl, François Mitterrand, and Jacques Delors two decades ago.

Their challenge will be to cobble together and mobilize support for a sweeping continental grand bargain that compels surplus and deficit countries to voluntarily agree to do things each would rather avoid but can no longer afford to do without. It could, for example, involve German consent for the European Central Bank to issue Eurobonds to cover the debts of euro-zone countries unable to tap private markets at affordable rates. In return, those borrowing countries might be called on to commit themselves to a five-year measured glide path to conformity with the debt and deficit guidelines of the European Stability and growth Pact. The five-year countdown clock could start ticking once recovery from the current recession begins, as measured by four consecutive quarters of positive growth. The glide path would be formally voluntary, but access to Eurobond financing would depend on meeting the intermediate annual benchmarks.

The grand bargain might take other forms. Whatever is agreed upon will be tough medicine all around. And it is hard to envision any of Europe’s current national leaders—Angela Merkel, Nicolas Sarkozy, David Cameron, or Silvio Berlusconi—or Brussels Eurocrats like Council president Herman Van Rompuy or Commission president José Barroso taking on the difficult intra-European diplomacy necessary for stitching such a bargain together and then summoning the continent-wide credibility and charisma to win it broad, transnational popular support.

Chancellor Merkel, more than any of her postwar predecessors, has chosen to stress German national interests over Europe as a whole—or, more accurately, at the expense of Europe as a whole. Germany’s soaring trade surpluses make it harder for the rest of Europe to generate the surpluses they need to pay their bills. In addition, Merkel’s hard-line insistence that deficit countries adopt German-dictated austerity policies makes it impossible for countries like Greece and Ireland to grow fast enough to reduce their towering debt-to-GDP ratios.

President Sarkozy dreams big. But he has neither the economic gravitas nor the political skills to be Europe’s economic leader, and France lacks the economic weight and dynamism to lead alone. So he tried to hitch himself to a reluctant Merkel in an attempted reprise of the successful Charles de Gaulle-Konrad Adenauer and Mitterrand-Kohl partnerships of the past. With neither partner cast for that role, it has not been a pretty performance, offending other European partners with its presumption, while alarming the bond markets with its clumsiness.

British Prime Minister Cameron is even more poorly positioned. He leads a coalition divided on Europe, a party dominated by Euroskeptics, and a country that chooses to remain outside the euro and a host of other Europe-wide arrangements. At home, he has embarked on a radical and risky experiment in ideologically-driven austerity that few others would voluntarily emulate.

Italy’s Prime Minister Berlusconi has personal distractions and national liabilities. And even a highly qualified Italian like Mario Draghi, governor of the Bank of Italy, has seen his candidacy for the presidency of the European Central Bank stir up snooty north European prejudices against Italian economic stereotypes.

We could explore further, but our search would still turn up no plausible European economic leader.

The Necessity for Long-Term Vision

It is a truism to say that a common currency requires a common fiscal policy. The euro’s designers understood that. What they counted on was a continuation of the same deepening dynamic that has nudged the European project forward since its inception, beginning with the European Coal and Steel Community of 1952. The six-country Europe of the 1957 Treaty of Rome eventually became the 27country Europe of today. The European Common Market became the European Community and then the European union. Each step marked a deeper level of supranational commitment.

Some argue that Europe simply grew too big and diverse. The levels of coordination that Germany could contemplate with states roughly comparable to it in terms of wealth and development, like France, could not be agreed upon with much poorer and less competitive economies like Greece and Portugal. But while Greece joined in 1981 and Portugal in 1986, Europe’s financial crisis only began in 2009. Instead, the crisis points to two other factors: the global financial crash and Germany’s post unification turn toward narrow nationalism.

Europe’s economic model is broadly Keynesian, committed to the social market economy and the welfare state. That means a housing and financial crash will rapidly push up deficits as tax revenues fall, relief payments rise, and governments try to stimulate demand. Furthermore, central banks provide added liquidity to weakened and overleveraged banks.

If the Keynesian consensus for counter-cyclical stimulus preached by political leaders like Barack Obama and Gordon Brown, as well as Nobel prize-winning economists like Paul Krugman and Joseph Stiglitz, had held, bond buyers might have accepted current elevated deficit levels as cyclical and stayed in for the longer haul. But with the political rise of pre-Keynesian budget balancers on both sides of the Atlantic, those investors have started insisting on austerity now.

Chancellor Merkel epitomizes this pre-Keynesian approach, even though Germany was out of compliance with the euro-zone’s convergence criteria from 2003 to 2006 and is still out of compliance on overall debt. Yet Germany now asks why the Irish and the Greeks cannot do what the Germans eventually did and force their accounts back into balance. They cannot because there is no way of reducing debt-to-GDP ratios without room for GDP growth. Economic sovereignty in Europe is theoretically available to the poor as well as the rich, but that is like the old saw that the rich and the poor have an equal right to sleep under a bridge. Greece and Ireland have already had to bow to the austerity demands of the Germans and the bond markets. Portugal, Spain, and Italy are doing what they can to avoid the same fate. Germany, meanwhile, looks to narrow German self-interest, myopically conceived. Export-dependent economies cannot long prosper if they force their leading customers to contract. A deutschmark cut loose from the euro would increase the price and decrease the competitiveness of German exports.

Within the euro zone there are no self-correcting mechanisms at work. Continued drift almost assures a euro crash. Dark days loom ahead unless Europe can find economic leaders with a long-term European vision. It looks like an impossibility. But it has become a necessity.

David C. Unger is a member of The New York Times Editorial Board who writes weekly foreign policy editorials from Europe. His new book, The Emergency State: How to End America’s Obsessive Quest for National Security And Reclaim our Democracy, will be published by Penguin, North America in January 2012. He has been teaching American Foreign Policy at the Bologna Center since 2009.