German hegemony in the euro-zone?

Germany is increasingly playing the role of a reluctant hegemon within the euro-zone

Simon Bulmer
Simon Bulmer

The deal to bail out Cyprus’s banks has reinforced concern about Germany’s growing power in the euro-zone. It is seen as symbolising a new ‘German Europe’.  How has this situation come about and are fears of German hegemony justified? Five reasons can be identified to explain the rising concerns about German hegemony.

The first derives from economic fundamentals. Whether it is population, GDP per capita, unemployment or real labour unit costs, Germany is the clear leader amongst the large EU states. It is Germany’s trade performance that is most striking, with a large surplus of €154bn in 2010, of which €68 bn was with its EU partners.  Its budget deficit is below the 3 per cent of GDP reference point in the euro-zone’s Stability and Growth Pact, but public debt is over the 60 per cent criterion. In all respects it is performing better than its major EU partners.

The second reason derives from the way in which German pre-eminence has emerged. Economically, France has fallen back, and the loss of its ‘AAA’ rating in January 2012 symbolically ended any pretence to a balanced Franco-German relationship within Europe.  Divisions between President Hollande and Chancellor Merkel on the balance between austerity and growth are a specific problem, but German ideas have prevailed.

Thirdly, the decline in the Franco-German relationship has gone hand-in-hand with waning German enthusiasm for European integration. Generational change has affected German political elites. Re-unification in 1990 removed important political constraints and helped create greater self-confidence.  Following the integrationist years of Chancellor Helmut Kohl, Germany has now emerged as a normal member state, willing to invoke the national interest and, in the euro-zone crisis, act unilaterally.

Not to be overlooked is the German state’s commitment to ‘sound money’, based on the principles of ordoliberal (or neo-classical) economics. Whilst the political goal of integration took the headlines in German European policy, there was a separate motivation that saw an integrated Europe as offering a market-place for German trade.  The decline in ‘integrationism’ and the euro-zone crisis has brought this ‘sound money’ approach to the fore.  This is the fourth explanation.

The ordoliberal approach sees little need for economic policy coordination across the euro-zone, providing that all states are following the correct ‘sound money’ policies.  Its approach to trade imbalances is that other states should make competitive adjustments. Germany’s huge trade surpluses might be destabilising, but it is others who should adjust. The ‘sound money’ approach is also opposed to euro-bonds (and even the intervention by the European Central Bank (ECB) with ‘Outright Monetary Transactions’) on the basis of the resultant moral hazard.

The fifth explanation is that Germany has been especially influential within the Troika in shaping both euro-zone bailout terms and wider policy measures, like the Fiscal Compact.  In the latter, it secured legally binding budget rules for euro-zone states, comparable to its own recently agreed domestic rules. On the bailouts, it has stuck to a policy of conditionality, stipulating ‘haircuts’ of bondholders (Greece) and bank deposit holders (Cyprus).  Alas, the underlying assumption that debtor states can swiftly adjust to German levels of competitiveness and debt looks unrealistic.

Together, these factors have raised concerns about German hegemony. So, are these fears justified? The answer is: Yes, but …

If not Germany, then who else is to take the lead? The European Commission, or the President of the European Council? They have been unable to take decisive action to appease financial markets. The ECB can only deal with monetary matters.  Angela Merkel was in fact criticised for prevarication over the initial Greek bailout. In 2012 Polish Foreign Minister Sikorski expressed a different concern, also heard during the crisis: ‘I fear Germany’s power less than I do its inactivity’.

Burdened by the shadow of history, Germany has in effect been criticised for showing both too much and too little leadership! Putting in place a set of EU rules should at least delegate new powers to the EU, even if with a distinctly ordoliberal flavour.  Perhaps the real EU deficiency during the euro-zone crisis has been the lack of a political decision-making ‘centre’ to deal with events as they happen.

And yet there are grounds for Sikorski’s concerns. Not since the 1950s have the ‘domestic politics’ of German European policy been so contentious. The parties within the coalition government have been jockeying for position to demonstrate their adherence to sound money principles.  With a regular cycle of state elections and the federal election scheduled (on a fixed date) in autumn 2013, the stakes are high.

Germany’s tabloid press has also shaped opinion with tales of feckless southern Europeans. Even the ECB’s intervention was presented in a Bild Zeitung headline as ‘blank cheque for debtor states’. With a federal election ahead, public opinion will be neglected at politicians’ peril.

A further key development has been the role of the Federal Constitutional Court. This body has guarded German sovereignty since its first pronouncement on the compatibility of the Maastricht Treaty with the German constitution. In successive rulings on the bailout funds it has set requirements for explicit authorisation by Parliament of key decisions, such as increasing the funding of the European Stability Mechanism. This requirement may well combine with politicisation to result in Germany not agreeing to some future measure essential to the euro-zone’s survival.

Domestic developments represent one limit on German hegemony.  Another is the need for consent amongst partners. Whilst the German Parliament has to authorise bailouts, in Cyprus the government is forced to circumvent parliamentary approval or in Greece the electoral process has to deliver the ‘right result’ before the funding is forthcoming.  US hegemony was dependent on a broad agreement on the principles of economic policy. The creditor-debtor cleavage in the euro-zone looks unsustainable over the medium-to-long term.

German hegemony has hesitatingly gone some way to resolving the immediate manifestations of the euro-zone crisis. But, as the years of painful adjustment lie ahead and the risk of political unrest in debtor states grows, bigger challenges will emerge.

If consent to this hegemony fails internationally or at home, there will be a more serious risk to the euro-zone economy.  At that point, those very same economic fundamentals that underpin German hegemony might lead to the conclusion that the only viable competitive adjustment would be for Germany itself to leave the single currency.