Germany learned a 2 trillion euro lesson after reunification which it is not going to easily forget

Politicians and commentators from all over Europe and beyond are pointing the finger of blame at Germany, asking why Chancellor Angela Merkel is unwilling to abandon her commitment to austerity. With Germany enjoying historic lows in unemployment, why is she resisting calls to open her purse strings to help the eurozone's floundering members? It is worth examining why Germans see things differently.

The electorates in France and Greece have shown that they are not willing to support a sustainable fiscal policy. Most striking is the voters' behaviour in Greece. While the majority of Greeks do not want to leave the eurozone, let alone the European Union, the parties that support the adjustment programme received a mere third of all votes.

This contradictory pattern is well known. For decades, election campaigns in European democracies were like beauty contests. Politicians outbid each other and promised ever rising benefits. While Greece might be the most extreme case, politics in many other wealthy countries was not much different.

Germany was no exception. In the early 1990s, Chancellor Kohl promised to deliver unification at little cost and with benefits to all. The reality has been different. Despite a torrent of money flowing eastwards, eastern Germany has not been an economic success.

The first 20 years of unification saw gross transfers of 2 trillion euros. This led to a jump in income levels in the East, but not to a sustainable catch-up. Western Germany continues to grow at a much faster pace than the East. The failure of that debt- financed economic stimulus is not forgotten in Germany.

Another experience that continues to haunt the German psyche is the hyperinflation of the 1920s, in which millions of people lost their savings. In Germany, imprudent fiscal policy will inevitably be linked to the risk of high inflation.

This limited desire for short-termism in fiscal policy will pose a problem for the opposition in the 2013 election campaign. The German Social Democrats, who hope for a change of government next year, are both criticising the Government's un-willingness to create a fiscal stimulus for the German economy while complaining about the slack implementation of the constitutional debt break, which prohibits a dramatic rise of public spending.

Klaus von Dohnanyi, the Social Democrat elder statesman, has supported Chancellor Merkel, accusing his own party of hypocrisy. Without a prudent fiscal policy and the will to implement structural reforms, he suggests, there will be no bright future for the European Union.

Or, as some radical voices have begun to suggest, there will not be a future for the EU at all.

Arnulf Baring, the conservative historian and outspoken critic of the euro, has been asking whether monetary union represents some kind of 'Versailles without war' - a reference to the 1919 Treaty of Versailles under which Germany had to pay punitive reparations after the First World War. Why, he asks, should the fiscally prudent - Germany and a few other northern European countries - reward profligacy elsewhere and bail out countries in the South, including Italy and potentially one day France?

Paul Krugman, the American Nobel laureate in economics, has been suggesting that deficit spending, and not structural reform, is the only remedy for Europe. Such campaigns as his ignore that many of the countries in trouble are in fact not implementing conventional austerity programmes at all.

In Spain, for instance, the Government spent 350 billion euros in 2005 and 468.5 billion euros in 2011, an increase of 33.8 per cent. In Greece, government expenditure rose from 86.1 billion euros in 2005, to 107.8 billion euros in 2011, an increase of 25.2 per cent. Spain is suffering primarily from the bursting of one of the biggest property bubbles in financial history, and Greece is confronted with the legacy of decades of bad governance. The picture in Ireland and Italy is not structurally different. Deficit spending will - many German commentators argue - only postpone the inevitable rude awakening.

Today, there is a growing recognition in Germany that its large current account surpluses will have to be corrected, either by raising wages or domestic investment. We can see the first signs of that in the 4 per cent annual wage rise agreed in May by German industrial employers and the powerful IG Metall union. The increase follows years of wage restraint and will be seen as helping to boost German consumption and so reduce the imbalances between Germany and other eurozone members.

But no one should imagine that Germany is going on a spending spree. Sustainable economic and fiscal policy is a key component of the political debate in Germany, and even the Free Democrats, a traditionally low-tax party, have abandoned this goal in favour of reducing public debt.

Some foreign observers seem to both overestimate the medium-term strength of Germany and to underestimate the level of economic literacy of its citizens. They are well aware that the current spell in the sun is exactly that: It will not last beyond the current decade. Demographic change will result in much weaker economic prospects for Germany. Within 15 years, the potential labour force will shrink from today's 44.5 million to 38 million. Like other ageing societies, Germany will have to service its public debt with ever fewer citizens.

Given its demographic structure, fiscal prudence is inevitable. Chancellor Merkel will have a chance to make this point in the 2013 federal elections. In contrast to some other electorates, voters in Germany appear willing to accept the short-term effects of fiscal discipline. Merkel's uncompromising position on new borrowing may be causing difficulties abroad, but it is earning her praise at home. Although it is dif-ficult to make predictions about the elections in 2013, there is a strong chance that citizens in Germany will reward her performance in the European crisis.

In the short term, the issue is dealing with the economic turbulence in Spain. While Spain faces serious problems due to the bursting of its property bubble, the Spanish economy appears to be able to compete and Spanish society able to reform its economic structures.

If eurozone countries need liquidity assistance, it is reasonable to expect substantial support for both Spain and Italy from Germany. For Chancellor Merkel, the red line is the creation of permanent transfer mechanisms that reward bad governance and uncompetitive economic structures. Short-term liquidity assistance that provides a bridge in tumultuous times is sensible; everlasting subsidies are not.

(Heribert Dieter is senior associate at the German Institute for International and Security Affairs, Berlin.)

 

 

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