German Force-Fed Austerity to Hurt for Years: Sebastian Dullien

Only a few months ago, there was an intense debate and a lot of resistance in Germany to setting up the European Financial Stability Facility and European Stability Mechanism. Part of the resistance wasn’t about the billions of euros lent to weaker partners in the currency, but about whether the German parliament was giving away too much sovereignty.

Against this background, the fiscal compact the German Chancellor Angela Merkel has pushed for, and which now will be included in a new treaty, must have come as a surprise. After all, the new rules give away even more national sovereignty.

The agreement all but cedes the euro-zone countries’ individual rights to borrow in financial markets and reduces their national parliaments’ room to set policy. This can only be understood in the context of the very specific German debate. Within Germany, the perception is that the Germans have been fiscally responsible and that the new treaty is just putting into a binding rule what the country has been doing all along.

Although this perception isn’t quite correct, given Germany’s violations of the Stability and Growth Pact in the early 2000s, it holds a grain of truth: The new rules are modeled after a rule that Germany wrote into its constitution in 2009, limiting structural deficits to 0.35 percent of annual output. As long as the German budget is in line with the German constitution, the country has no problems fulfilling the new commitments.

The German government’s approach, however, is likely to come with a lot of collateral damage.

First, the agreement has alienated smaller European partners, which now will have little say in European Union affairs.

Second, failing to get the British to agree to treaty changes, the EU might lose relevance in regulatory and foreign policy issues. That would mean reduced global influence for Europe.

Third, while the German government calls the reforms a fiscal union, such a union means joint liability for certain types of public debt as well as taxation and spending powers to counteract adverse economic developments. Such a union would make sense: The current crisis isn’t merely a result of profligate governments, but stems from the imbalances that have led to boom and bust cycles in the euro periphery.

In principle, more centralized fiscal and economic policies, including regional transfers, could prevent or damp such cycles. The proposed set-up does nothing to correct or prevent new imbalances, though. The underlying problems of weak economic growth in the euro area aren’t solved, and may be made worse by years of austerity.

More treaty changes will be needed to turn the currency union into an economic entity that can deliver more than economic stagnation and price stability. Europe’s leaders need to admit to their constituencies that the euro area will never become a dynamic economy if monetary union isn’t complemented by a real fiscal union, including EU power of taxation, a much larger EU budget and the ability to issue euro bonds. Unfortunately, in spite of almost monthly crisis summits, such a solution still seems a long way off.

(Sebastian Dullien is professor of international economics at HTW Berlin-University of Applied Sciences and senior policy fellow at the European Council on Foreign Relations. The opinions expressed are his own.)

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