Germany risks losing EU moral leadership over handling of Greece

Germany, led by Angela Merkel, is at present the leading country in the EU and deservedly so. The standing of President Hollande though bolstered by his sure handling of the crisis caused by the shooting of Charlie Hebdo staff and Jewish hostages, is weakened by his having come to power on the basis of policies that could not work and have had to be reversed; the UK’s policy towards the EU changes day by day largely driven by the nationalist UK Independence Party and the rightwing of the governing Conservative Party; and, though Italy has a stronger than usual government under the youthful Matteo Renzi, that follows 20 years dominated by a politician in constant trouble with the judiciary for tax evasion and other illegal business practices, and Renzi acknowledges that the standing of Italy depends on the success or otherwise of a 1,000 day reform programme.

Germany has achieved not only political stability and economic strength, but also moral leadership resulting from a number of factors;

First, it has achieved what can rightly be called a social market economy. Its competitiveness is combined by company structures which give employees a large say through works councils and supervisory boards and a large proportion of companies are located in their communities and feel a social obligation to those communities particularly in providing younger ones with high quality training schemes. Trade unions though they come sometimes cause disruption through industrial action still have a respected role in large parts of the economy.

Second, Germany has a consistent foreign policy based on support for the EU, and for NATO as a defensive alliance, while taking a very cautious approach to military interventions elsewhere in the world. With regard to the EU’s largest neighbour, Russia, Germany has made strenuous efforts to achieve good and stable relations but has recongised that Russia’s incursions into Ukraine are unacceptable and have to be resisted by economic sanctions.

Third, Germany has in recent decades, become a country open to large scale immigration. Although immigration under the free movement principle from other EU countries is higher than to the UK it has not led to controversy and it has taken more refugees from Syria than most other EU countries (albeit little in relation to those in Lebanon, Turkey and Jordan). The anti-Islamic Pegida movement is a cause for concern but its support is still much less than for the UK Independence Party or France’s Front National, and it has been categorically condemned by Mrs Merkel.

However, although German policy under Angela Merkel and the finance minister, Wolfgang Schauble, has contributed to keeping the euro zone together since it was hit by crisis six years ago (first in Greece, but then spreading), the soundness of its policy has been open to question as has whether it is a genuine European policy or one designed to protect narrower German interests. In the early years of the euro, Germany, despite having strongly insisted that members of the euro zone must be underpinned by strong economic fundamentals as set out in the so called Maastricht criteria in the 1992 Maastricht treaty, failed to enforce these criteria. Countries were allowed to join the euro zone which only on a very generous interpretation of the rules met the Maastricht criteria, and most egregiously Greece joined two years after the others on figures which it was known had been manipulated by advisers from Goldman Sachs. While Germany was itself breaking the Maastricht rules in the early 2000s, investors poured money into Greek and other south European government bonds and banks with no effective warning of the dangers from the European Central Bank then still largely dominated by German thinking (its then chief economist, Otmar Issing is German).

Germany acknowledges that it made mistakes during this early period in the history of the euro, but the only lessons its policy makers draw is that fiscal discipline must now be imposed ruthlessly in very different times. They do not want to allow Greece,  after six years of economic and social turmoil, Greece should be allowed a new start and that even a small part of the adverse consequences of past mistakes should be borne by the richer countries. Unattributed comments from German government sources have suggested that Germany would be relaxed about Greece leaving the euro, if a new government  questions the policies being imposed on it and whether it can ever reasonably be expected to pay back its foreign public debt. If, after suffering more than any other EU economy has ever suffered since the beginning of the euro, in order with the aim of remaining in the euro, Greece were to be effectively expelled because of disagreements with a newly elected government, the economic contagion might be containable (as it would not have been in earlier years), but the political contagion resulting from a breakdown of EU solidarity would be unpredictable and irreversible.

It is understandable that Germany does not want to sign blank cheques for transfers to poorer EU members similar to those West Germany has provided and still is providing to other Germans in eastern Germany. The EU, Germans reasonably insist, is not a “transfer union”. But, with Greece now running a primary surplus (excluding interest payments) on its government accounts, demands that it should fully service and eventually pay back its 177% of GDP debt are in effect demands for transfers from Greece to richer countries in exchange for the poisoned chalice of inflows in the 2000s whose impact on the Greek economy was almost entirely harmful.

That said, it has to be admitted that a negotiated writedown of Greek debt will not in practice be easy or quick. The more aggressive stance of the victorious Syriza towards the demands of the Troika (IMF, European Commission and European Central Bank) can not be seen to be immediately rewarded in preference to New Democracy’s more cooperative approach.

Secondly, although Germany does to a considerable extent pull the strings of the Troika, it is not all-powerful. First the IMF cannot consider any forgiveness of its debt. It is not an EU institution and represents many other countries, mainly much poorer than the EU. The IMF can continue to offer advice from its wide experience on policy reforms but it cannot be part of the debate on fiscal obligations within the euro zone. The European Commission and the ECB with regard to its role in the Troika–,which is completely separate from its main function of setting monetary policy on which it is independent–are effectively constrained by euro zone member states, of which Germany is the most powerful, but not of course the only one. Through the European Stability Mechanism all other euro zone countries, both strong and weak, have stakes in Greek debt and would correspondingly share in any debt write-down. Logically opposition to such a write-down should come most from the weaker countries though that does not seem to be the case. The most hardline stance is that taken by the prime minister of Finland, Alexander Stubb. Finland presents a unique problem. It is an anomaly in the euro zone in that it is the only Nordic member and its original decision to join was taken by the government of the time against a much degree of opposition than in other member states at the time of joining. The government there is under pressure from the nationalist True Finns (as though other parties were not truly Finnish) which makes a big issue of providing “help” to allegedly profligate southern Europeans. Finland might have to be treated as an anomaly and excluded from any deal. Of more concern should be adding to the debt of weaker member states but given the relatively small size of the Greek economy, and that lending to it is shared between all the other euro zone states, a substantial write-down of the €320bn debt is not going to have a dramatic impact on any of the others.

A final concern is to what extent a write-down of Greek debt would lead to other indebted euro zone countries to demand their own write-downs. But the only other country which may need such a write-down is Portugal and this would be to a lesser extent than for Greece. Italy’s public debt to GDP ratio is 130% but the country has lived with a similar ratio for 20 years, since before it joined the euro, and a high proportion of its debt is held domestically. Ireland also has a high debt to GDP ratio, but is now coming out of its prolonged recession and has always despite cuts in living standards, been one of the richest countries in the euro zone. Spain’s public sector debt is lower  and similar to that of Germany’s.

Moves to tackle Greece’s unmanageable debt will take time and the new Greek government will have to ensure that its accounts remain in primary surplus, but after six years of painful measures, it would  be wrong to prevent it from taking measures to ease the hardship of the most vulnerable people or to push it into even deeper cuts in expenditure to meet the demands of creditors and even more wrong to remove Greece from the euro zone as an answer to an impasse in the negotiations.