Is the EU's Future Deutschland Über Alles?

With the latest economic crisis shaking confidence in the euro zone, some prophets of doom are already predicting the end of the European Union (EU). These calls are misguided—and often tainted with an unmistakable whiff of schadenfreude.

Yet the credit crisis roiling the European economy is highly significant and will likely redefine not only Europe's relationship with the rest of the world, in the context of the overall Bretton Woods security arrangement, but also the future of intra-European integration.

As the main economic engine behind the EU, Germany could have let the markets discipline the fiscally permissive Greeks. But in so doing, Germany would have risked scuttling the European project. Instead, German Chancellor Angela Merkel chose to step in and provide support, albeit with many strings attached.

The European Union as a construct is crucial to German economic and physical security. Just as much as Germany needs the EU, though, the EU is beholden to Germany.

German Wrath

The Germans agreed to shoulder a significant portion of the bailout burden, despite relatively high levels of domestic unemployment. But German taxpayers are angry that having subsidized Greece's integration into the EU through such programs as the CAP (Common Agricultural Policy), they are now being asked by their government to cough up more money for the sake of the euro.

As the euro loses value—recently dropping below $1.20—the German economy benefits via increased exports. The Germans have made sweeping verbal pledges relating to the stability of the common currency, but they refrained for a long time from making specific commitments to a Greek bailout or spelling out such details as terms and conditions, interest rates, or actual disbursement amounts.

That Germany waited this long—playing a form of Russian financial roulette before getting serious about a bailout—is not as irrational as one might think.

A Game of Brinksmanship?

German high-end exports to Asia and other parts of the world have surged, thanks to the weaker euro and overall economic recovery. Unemployment figures for Germany in April and May were below expectations, with export-oriented sectors contributing the most to the job gains. The labor market was also helped by Germany's Kurzabeit program, under which the state subsidizes workers who agree to work fewer hours, thus minimizing layoffs.

Machine orders were up 21 percent in March and 36 percent in April, with Asia serving as the final destination for many shipments. Overall, exports from Germany amount to roughly €1 trillion a year and account for 45 percent of its GDP, compared with €440 billion, or 22 percent of GDP, for France. Moreover, 25 percent of Germany's exports go to emerging countries, vs. just 15 percent for France.

German stalling vis-à-vis the Greece situation may well have been part of a sophisticated game of brinkmanship to keep the euro weak and encourage export-led growth. The Greeks and other struggling European economies are caught between a rock and a hard place; what's good for Europe's peripheral, nonexport-oriented economies is not necessarily good for Germany.

Moreover, now the Germans have all the leverage they need to extract maximum concessions from all EU participants.

Gaining Continental Clout

One could argue that from an economic security standpoint, Germany was able to achieve with the EU what it failed to achieve in two bloody wars in the last century. From Germany's perspective, it has invested far too much in the euro simply to let it flounder now. The EU is an institution of great significance for an otherwise geographically vulnerable Germany that has no natural land or sea barriers protecting it from Russia in the Northern European plain.

By tying Europe's peripheral economies to its export-driven economic engine, Germany was able to supercharge growth for the latter half of the last century. The only negative for Germany has been the periphery's spendthrift ways; but now the mounting debt woes of Europe's poorer states will allow Germany to gain the Continental clout it has long sought.

Thus far, the skepticism expressed in the market hasn't so much been about the EU/IMF rescue package for Greece per se (as the deal will buy enough time for Greece to get its fiscal act together) but about the political will and ability of the Greek government to stick to the austerity measures to which it has committed. With images flashed around the world of Greek protesters storming the Acropolis and clashing with riot police, it will take more than promises to satisfy investors.

Devaluation Not an Option

Ultimately, many other European countries also will have to take a hard look in the mirror and make difficult choices on pension benefit plans, retirement ages, and other structural factors in their economies. With GDP growth over the next few years expected to be muted in Greece, Spain, and Italy, simply growing out of the deficit is not an option. Moreover, the inability to devalue a national currency compounds the problem and further reduces the periphery's range of options.

Italy just announced measures to cut €24 billion from its budget, while Spain, France, and the U.K. all have taken steps to address their deficit spending problems. Germany has already raised its legal retirement age to 65 and completed pension reforms; cuts in social and health care benefits during the first half of the decade appear prescient with hindsight. Chancellor Angela Merkel also just spelled out more than €80 billion in budget cuts over the next few years.

The political will to make the necessary cuts will get stronger over time as Europe is faced with a stark choice: Becoming competitive, or being reduced to geopolitical irrelevance by rising powers.

A Turkish Counterweight

This is where a Germany that is more active within the EU comes in. By having a greater say in Europe's fiscal and political affairs, Germany will not only strengthen European institutional integration but also effectively police the periphery's finances. Over time, it will also provide increasing direction to the military and defense dimension of the EU.

Germany's role as the main export economy of the EU also helps explain its resistance to Turkey's EU accession. After all, Germany now hosts more than 3 million residents of Turkish origin, so cultural arguments about Turkey's difficulty integrating with the EU seem specious, at best. The truth is, Germany is simply unenthusiastic about admitting a large country to the EU that could challenge its de facto Continental dominance. The U.K., long suspicious of a Teutonic-oriented Europe, has consistently been one of the strongest backers of Turkey's EU aspirations. Over time, we may see other countries back Turkish accession as a counterweight to German influence.

What's certain is that the European sovereign debt crisis will see Germany emerge with a greater say in Europe's fiscal and economic affairs. And to the consternation of its detractors, the EU will become more, not less, relevant over time.

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