Delicate balancing act

IFR Germany Report 2012
8 min read

Chancellor Angela Merkel is an increasingly lone voice. Several eurozone governments have fallen and the change of president in France has threatened to put pay to austerity politics.

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The day after the presidential election victory of Franςois Hollande in France, the front page of a leading German tabloid warned: “Good morning Chancellor. This is now the most important man in your political life.”

It was all so different before Christmas. With Jean-Claude Trichet at the European Central Bank in Frankfurt and with Nicolas Sarkozy in the Elysee Palace in Paris, German Chancellor Angela Merkel was comfortably in the eurozone driving seat pushing the message of austerity.

Even in March, Germany was the piper that called the tune. Back then a full 25 of the 27 eurozone countries inked Merkel’s fiscal pact at the EU summit.

But now Merkel is looking a trifle isolated. Only three eurozone members – Portugal, Greece and Slovenia – have ratified Germany’s fiscal pact, there is no chance at all that France will sign up, and her message of austerity is sounding a little shrill.

Fights over belt-tightening have seen several European governments tumble over the past few months, notably in Spain, Ireland and the Netherlands – the last, one of only four Triple A rated European states.

At the same time as the French were rejecting Nicolas Sarkozy, a much more bad-tempered general election was taking place in Greece. The two main coalition parties – those who have been championing both the euro rescue and austerity fell short of a majority. This makes a Greek exit from the euro look increasingly likely.

In fact, this looks like the end of austerity politics. In his election victory speech, Hollande said that he hoped that his election meant that: “Austerity does not have to be inevitable.” While Mario Draghi, Trichet’s successor at the ECB, kept eurozone interest rates at an all time low of 1% in the May rates decision meeting, said: “We have to put growth back at the centre of the agenda.”

Merkel has started to shift her stance slightly away from plain vanilla austerity, but does not sound convincing while doing so. At the end of April – notably after Hollande’s success in the first round of the French presidential elections – she admitted through visibly clenched teeth that fiscal policy alone could not solve the eurozone debt crisis.

“We need growth in the form of sustainable initiatives, not stimulus programmes which would increase debt, but growth in the form of structural reforms,” she said in a speech in Berlin.

Her discomfort in delivering such a message reveals the extent to which the eurozone crisis has put Merkel in an impossibly difficult position. The relentless austerity that she has had to push is partly the result of her own country’s economic success and highlights how far apart the eurozone is economically.

Cheerful reading

Growth in Germany does appear unstoppable. The spring economic report from the German research institutes makes for cheerful reading… if you are German. GDP is expected to grow 0.9% this year and 2% next year. And German unemployment continues to drop. At the moment it is at 6.7%, or 2.8m, the lowest rate since the fall of the Berlin Wall in 1990. Indeed, the unemployment peak during the 2008–09 recession was an enviable 7.9%. And to put those figures into even starker perspective, German youth unemployment sits at 8.2% compared with Spain’s 50.5%.

The economy’s performance is primarily down to its success as an exporter, most significantly with Asia. German exports to China hit €65bn last year. A sign of how important Asia has become is that that figure has more than doubled during the past five years.

This is all good news, but beneath the surface tensions remain. Salaries are rising in Germany. For example, the country’s Beamte – civil servants – have managed to get hold of a pay rise of 6.3% for the next two years, while IG Metall, Germany’s engineering union, is demanding a 6.5% pay hike for this year alone. Also on the rise is Germany’s historical bugbear: inflation. Although a manageable rate of 2% at the moment, the spectre of an inflation rate of 4% and 5% is looming, say the doom-mongers.

The natural answer would be to increase interest rates, and that is precisely where the tension has grown between Germany’s ultra-conservative Bundesbank, and the ECB over the past year. The Germans are inflationary hawks; much of the rest of Europe is not.

German adherence to austerity and its opposition to ECB extraordinary measures (such as the €1trn LTRO) saw both chief economist Jürgen Starck and Bundesbank president Axel Weber resign from the ECB’s board last year. Draghi is likely to cut interest rates before the end of the year to help indebted and struggling southern Europe, which will fuel tensions further.

The question that Germans keep asking themselves is to what extent eurozone malaise will drag Germany down with it if austerity is completely rejected. Economic Cassandras warn that the country is putting an awful lot of faith on a fairly narrow range of exports. Cars, machinery and chemicals account for more than half of the country’s exports.

The car industry – the jewel in Germany’s manufacturing crown – shows this concern clearly. Although Germans themselves are still buying cars, the French market tightened 23% year on year in March and the Italian market an eye-watering 27% year on year, according to European carmakers’ association Acea. Alarm bells are ringing in Ingolstadt and Munich as fewer new Audis and BMWs appear on Europe’s autostrade and autoroutes.

Unwanted responsibility

A further complication is that Germany itself goes to the polls next autumn. If Merkel’s hardline on austerity is winning her few friends in Europe, it is not doing much for her at home either. The German public are increasingly resentful of the country’s role as Europe’s sugar daddy.

After a string of public humiliations for her party, the Christian Democratic Union, in regional elections last year, 2012 is not shaping up to be any better. The CDU managed to remain the strongest party in the tiny western state of Saarland in March, winning more than a third of the vote. But her coalition partners, the Free Democratic Party, were knocked for six with a 1.5% share of the vote while her Social Democratic Party rivals won a greater than expected 30.6%.

It was the same story in early May. At the same time as the French were showing Sarkozy the door, the CDU lost power in the northern state of Schleswig-Holstein. Although the CDU did take 30.6% of the tally and the FDP won a better than expected 8.3%, according to ARD public television, this was not enough to retain power.

Saarland and Schleswig-Holstein might not be the most significant states in the German political calendar, but they are dress rehearsals for the much more important election in Germany’s most populous state North Rhine-Westphalia in mid-May. It was a loss there in 2005 that caused the then-Chancellor Gerhard Schröder to call a snap federal election, which he subsequently lost to Merkel.

While no one is predicting a wipe out for Merkel just yet, or even a loss in the general election next year, Merkel’s priority has to remain the economy. As long as exports keep flowing out of German factories and wages keep rising, she remains safe. Should these slow down, voters could deliver the same shock to Merkel that they have just done to Nicolas Sarkozy.

Cycling fan El Diablo climbs on his giant “soccer bicycle” in Storkow. REUTERS/Pawel Kopczynski
German Chancellor Angela Merkel smiles during a news conference at the Istana in Singapore. REUTERS/