Europe's largest economy must try harder. It has far more to lose from a collapse than any other country in the union
'The crisis of the euro is over. Crisis in the euro is strong." Thus a senior French politician. A looming collapse in Cyprus, which eurozone leaders will discuss after the European Union summit dinner in Brussels tomorrow, may yet prove him wrong in a matter of days. My hunch, though, is that he is probably right, at least for a year or two.
Germany and the European Central Bank have done just enough to convince the markets that the eurozone will survive, for now. But many eurozone economies remain on the critical list. Some have made heroic efforts, with results already visible. In Spain, for instance, unit labour costs are already down and exports are at a 30-year high. The pain has been immense, with 50% youth unemployment and house prices falling between 30% and 40%, but somehow people are getting through it. This has had political spin-off effects – literally so, encouraging Catalans to want to spin off from the Spanish state – but in terms of conventional party politics, the centre has held. There has been very little xenophobic rhetoric and virtually no scapegoating of immigrants.
What has happened in Spain is remarkable testimony to the resilience of the European political mainstream, with its almost instinctive commitment to moderation, bound up in a deep-rooted desire to remain part of a larger European project. But for how long, oh Lord, how long? For how many more years can these societies endure such levels of socioeconomic stress before their democratic politics lurch to extremes?
We have seen the danger already with the electoral success of the ultra-nationalist, xenophobic and (for once, the label is justified) neo-fascist Golden Dawn party in Greece. Quite different in kind, but larger in its political impact, is the Italian political impasse, which results from voters being split between the comedian Beppe Grillo's protest movement, Silvio Berlusconi and the left, plus a smaller vote for Mario Monti's "Monti for Italy" grouping, with the votes breaking differently in the two houses of parliament. With a stalemate between the two chambers, reform is stymied in the eurozone's third largest economy.
Some of this was inevitable, but it has been made worse by human error in general and German error in particular. I can entirely understand German voters' initial angry reaction to being asked to bail out other Europeans who had been much less disciplined, hard-working and productive than them, in order to save a currency which the Germans never voted to join. (In bringing down its unit labour costs, Spain is doing, in an involuntary crash course, what Germany started doing a decade ago, on its own initiative.) I would have felt that way myself. I can understand Angela Merkel and her colleagues hanging tough.
But facts are stubborn things. When the facts change, or at least become clearer, policies must be adjusted accordingly. The duty of politicians in a well-functioning liberal democracy is to recognise those facts and then explain them to voters, not to string voters along with waffle and false promises. Here's an example: the so-called fiscal multipliers, that is, the impact on GDP of a cut (or increase) in public spending. In normal times, when most of the countries with which you do business are faring OK, this multiplier may be as low as 0.2 or 0.4 – that is, GDP declines by some 0.2-0.4% for every 1% you cut public spending. But when everyone around is in recession, the effect is dramatically increased.
This was the case in the Great Depression, as the Oxford economic historian Kevin O'Rourke and his collaborators have clearly established. It is the case again today, in our Great Recession, as the economists at the IMF, the EU and other institutions are now acknowledging. In conditions of all-round recession, the fiscal multipliers can soar above one, so a 1% cut in public spending may cause a 1.5% drop in GDP. That significantly alters the calculus of austerity.
Here's another fact, slightly larger and therefore more contestable, but still quite firm: the pain of adjustment has been born mainly by the southern European "periphery", not the north European "core". Yet it took two to create this mess. Blame the feckless borrower in the south but also the shortsighted lender in the north – for instance, in German banks. That leads to another, only slightly more speculative statement. Germany has more to lose than any other country from a collapse of the eurozone. One estimate puts its banks' exposure to Greek, Spanish, Portuguese and Irish debtors alone at about €400bn. The German government's own council of economic advisers last year assessed the maximum potential losses to German creditors in a eurozone breakup at €2.8 trillion, topping the country's €2.65trn annual GDP. Any successor currency, be it an old-new Deutschmark or a north European euro (the Nordo or Neuro), would have a less advantageous exchange rate for German exports.
Not from any Keynesian dogma, not from idealism, not from sentimentality towards fellow Europeans, but in its own enlightened national interest, Germany needs to do more. It should increase its domestic demand, support a strong banking union, and embrace something like its own economic advisers' proposal for a limited mutualisation of eurozone debt – with appropriately stringent conditions. In terms of the political economy of the whole eurozone or, perhaps more accurately, its economy-driven politics, the best moment to do this has passed. That was what we must now call the Monti Moment.
As prime minister, Monti was wrestling manfully to do the right thing in Italy, but also urging Germany to do its part. Having failed to grasp that moment, Germany has one more opening. Whoever emerges as chancellor in the German general election this September, in whatever coalition, needs to go that extra kilometre to save the eurozone properly, making sure that future euro-crises are never again "of" but only "in". What people call "the European elections" are scheduled for June 2014, but the truly decisive elections for Europe are all national – and none more so than Germany's.
It is, of course, pure coincidence that Germany faces this challenge as we approach the 100th anniversary of 1914; but it is a coincidence that also reveals a historic opportunity for constructive European leadership by the continent's central power. Go on, Germany, seize what Fritz Stern once called your historic "second chance", and use it well.
Twitter: @fromTGA
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