European Affairs

In Germany, the report was met with outrage. Senior government officials, employers and many German economists mounted a fierce defense of the German model, arguing that a strong Germany is in the best European interest and that artificially weakening Germany’s economy would not help other countries, meaning Europe’s periphery and France, overcome their own structural problems. Many suspect that recurring attacks against the German model from across the Atlantic are politically motivated. Some observers even suggest that this may be an attempt to sow discord among Europeans and weaken the monetary union.

It is certainly true that the report provided political cover for the European Commission to finally open a review of Germany’s excessive trade surplus as part of the commission’s macroeconomic imbalances procedure. In September of this year the current account surplus (exports minus imports) reached 19.7 billion euros, and was the biggest surplus in the world, topping even China. (The surplus has diminished somewhat since then.) The Commission monitors each member country and flags abnormal deficits or surpluses to understand whether a national government should take corrective measures to address the imbalance. But the impact of these steps with regard to Germany is largely symbolic and likely to be short-lived. The Commission will not punish Germany. More importantly, European partners will continue to emulate the German, export-driven economic model.

Germany’s political and economic establishment has largely won the economic argument in Europe. Even French government officials privately recognize that their country needs to undertake structural reforms, such as reducing red tape and creating a more flexible labor market. The argument among Europeans is now largely focused on the timing and depth, and about who should shoulder the cost of these reforms.

Germany insists on bold structural reforms at a national level, arguing that acting with speed and courage will allow countries to overcome their slump more quickly. Angela Merkel wants to minimize costs to German taxpayers and believes that if European Union (EU) member states do their homework, things will improve without much help from Berlin.

Out of domestic political considerations, weaker European partners want to proceed much more cautiously. They are also arguing that reforms cannot be implemented for free and want Europe – in other words, Germany - to put more money on the table to mitigate the harsher effect of tough economic policies. But this ongoing squabble over the how, the what and the when should not be mistaken for any fundamental difference of opinions on strategy.

The new conventional economic wisdom in the old continent accepts that European growth now depends almost entirely on exogenous factors. It hinges on global demand for European goods and services. Indeed, while the imbalances within the monetary union are narrowing, the euro zone as a whole now has a sizeable current account surplus. If and as conditions improve, demand, both for investments as well as consumer goods, will make a comeback. Eventually, Europeans will start importing more goods and services from other parts of the world, including from the U.S. This view implies that market forces rather than government interventions - through stimulus packages – have the power to correct some of the current imbalances. Large German trade surpluses are merely viewed by Germans as a symptom, rather than as the underlying cause, for some of today’s problems.

Some of the most recent data seem to support this view. German imports are already rising, albeit mainly because the country’s manufacturing supply chain largely depends on unfinished products made in neighboring European countries. Also, German growth is increasingly supported by stronger domestic demand. Furthermore, the recent coalition agreement and its focus on income redistribution could be mildly supportive of stronger consumption, at least in the short term.

Ultimately, this new installment of the ongoing transatlantic rift between the administration and Chancellor Merkel and her economic policies, exposed radically different views on the very nature of the recent economic crisis.

The prevalent view in the U.S. – with some notable exceptions – maintains that recession and slow recovery were both caused by the depth of the financial crisis. Stimulating the economy with large doses of fiscal or monetary means should be viewed as mandatory. Stimulation should be able to address temporary weaknesses and allow the economy to reach what economists call escape velocity. Indeed, six years after the outbreak of the crisis, the economy is recovering, albeit painfully slowly.

The prevalent view in Germany is still deeply skeptical of this Keynesian response to the recession. The financial crisis merely exposed pre existing structural weaknesses in the worst hit economies. Artificially stimulating the economy is viewed as counterproductive.

The recent fight over the size and role of the German current account surplus can be seen as a symptom of a much larger rift between the US administration and Berlin, one about the very nature of the recent crisis. It is still too soon to say who will be right in the end.