Europe’s heavyweight weakling

Date: 07/06/03

Will a sick Germany continue to carry the rest of Europe?

“WE MUST get used to the idea that in future there will be one country in Europe that will be stronger than all the rest,” said Margaret Thatcher glumly in 1990. In the aftermath of the fall of the Berlin wall, Germany did indeed seem poised to emerge as the new Europe's unrivalled powerhouse. The renovation of eastern Germany would, it was assumed, give a huge stimulus to the country's economy. In addition, the newly-capitalist countries of central Europe would provide German industry with a new hinterland. And with the adoption of a single European currency, agreed upon in 1992, Germany would be able to lock in its competitive advantages. No longer would Europe's weaker economies be able to devalue their way out of competing head-on with Germany's industrial juggernaut.

More than a decade later, all this looks pretty foolish. Germany is now the sick man of the European Union. Since 1996 it has averaged growth of just 1.1% a year compared with 2.2% in the euro zone as a whole. For almost three years the economy has barely grown at all. A country which boasted unemployment of just 150,000 in 1970 may have 5m out of work by the end of the year. And Germany, which insisted that all countries adopting the euro should never run a budget deficit of more than 3% of GDP on pain of large fines, broke the 3% limit itself last year. Goldman Sachs, an investment bank, reckons that the deficit this year could top 4% and is likely once again to breach the 3% limit in 2004. That, if the law were strictly applied, could cost the country a fine of billions of euros, payable to the EU.

Germans are struggling to understand what is going on. Despite the renewed urgency with which Gerhard Schröder, the chancellor, is promoting economic reform, some of his compatriots continue to deny there is a problem. Life still looks pretty good on a sunny day in a city like Frankfurt or Munich. The autobahns are filled with BMWs; the shops and airports are busy. The figures show that Germany's is still the third largest economy in the world; the country is still richer per head than the EU average. But the gap is narrowing fast, and there is a growing sense of unease. Students with good degrees from top universities cannot find jobs; big companies are folding; the banks are under strain; and the pensions system is approaching crisis.

The trouble is that even those who agree that there is a problem cannot agree on its main source. Broadly speaking, there are three potential scapegoats: eastern Germany, the German welfare state and (sotto voce) the EU. Most Germans acknowledge that reunification was handled in a way that inflicted maximum economic damage. By translating the wages and welfare system of West Germany wholesale to the east, the politicians managed to saddle the west with huge bills while making the east hopelessly uncompetitive. But while many say that the main reason for Germany's malaise is the burden of the east, others say that the true source of the “German problem” is the complexity and generosity of the welfare state, which meant that average growth rates were already falling noticeably in the 1980s. Lavish benefits are funded by high payroll taxes, which discourage job creation and so increase the number of people who rely on benefits.

Almost all politicians now acknowledge the need for structural reforms but few are prepared to discuss a third possible explanation for Germany's economic weakness: the euro. By contrast, commentators outside Germany often identify at least three ways in which the German economy has been hit by monetary union. First, Germany appears to have joined the euro at an uncompetitive rate, making German products relatively expensive. Second, the single interest rate for euroland is too high for Germany, which, according to the IMF, is now threatened by deflation. Finally, the effort to abide by those fiendish budgetary rules is forcing the government to cut government spending, just as the economy slides into recession. To add insult to injury, Germany is the largest financier of the EU, the very institution that is now threatening to fine the country for its profligacy. Indeed, the €9.8 billion ($10.4 billion) that Germany contributed to Brussels's coffers in 2002 would have made a sizeable dent in the German deficit of €76.2 billion that year.

In many a country this catalogue of woes would provide ample fuel for a populist backlash. But not in Germany. Partly that is because the economics are complicated: cause and effect are often hard to disentangle. But it is also because Germany's traditional belief in the virtues of European integration is so deeply entrenched that it is almost politically incorrect to question the merits of the single currency. Prominent private-sector economists tend to talk only off the record when they express scepticism. One reckons that there is still a 25% chance that the euro will fail, adding mischievously that he believes that the Bundesbank has secretly kept an entire money supply's worth of marks in storage, just in case it ever became necessary to reissue the old currency.

Whisper it softly

Even when criticisms of the euro are aired publicly, they tend to be couched in very careful language. In a lucid exposition of Germany's economic woes, Hans-Werner Sinn of the Ifo institute in Munich points out that the creation of the single currency has wiped out a competitive advantage (relatively lower interest rates) that German companies used to enjoy over their European neighbours. But he then adds: “The beneficial effects of a unified European capital market cannot be questioned by a good European, even if Germany is unable to profit from it.”

Mr Schröder has often said that his goal is for Germany to become just a normal country. But the German willingness to accept unquestioningly the burdens of being a “good European” remains distinctly abnormal - a state of affairs that its European partners have good reason to give thanks for.

Will a sick Germany continue to carry the rest of Europe?

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