Published in Business Spectator (Melbourne), 4 August 2011

Every year, the Centre for Independent Studies hosts a high-level conference in Queensland. One of the speakers this year was Thilo Sarrazin, the author of the equally controversial and successful (1.3 million copies sold) book Deutschland schafft sich ab (‘Germany abolishes itself’). I discussed the mechanics of the European debt crisis with him over the past week.

Sarrazin is most well known these days for his outspokenness, or indeed bluntness, on the failures of the welfare state and multiculturalism. This makes it easy to forget that Sarrazin, who holds a PhD in economics from the University of Bonn, can look back on a long career in the public sector, particularly in fiscal and monetary policy.

One of Sarrazin’s most impressive achievements was in his time as treasurer in the State of Berlin from 2002 to 2009, where he managed to turn a deficit of €5.2 billion (or 25 per cent of the budget) to the first surplus in the post-War history of the German capital. As a senior official in the German federal treasury, Sarrazin was intimately involved in the design of monetary union in the course of Germany’s unification, and his last public position was as a board member of the Bundesbank, the German central bank.

Following his honourable resignation from the Bundesbank after publication of his book, Sarrazin has remained silent on fiscal and monetary matters. As he says, a sense of loyalty to his former employer had prevented him from answering media requests for comment on the eurozone crisis. However, as almost a year has passed since his departure he feels free to re-enter the debate on economic policy.

“There are clear parallels between the current situation in Europe and what happened in Germany at the time of unification,” he tells me. When the two German states unexpectedly faced the prospect of unification, it was clear that massive fiscal transfers from the rich West to the impoverished East would be necessary. “My estimates then about what was required to stabilise and rebuild East Germany turned out to be quite correct,” he says.

A study at the Free University of Berlin on the eve of the 20th anniversary of the fall of the Berlin Wall calculated the net cost of unification between 1990 and 2009 was €1.6 trillion. This is almost precisely the amount that Sarrazin had estimated back in 1990 when he forecast annual transfers of the order of around 170 billion Deutschmarks (€87 billion) over the first decade of unification, but the process continued over an even longer period.

“At the time of German unification, an attempt was made not to reveal the full cost of unification in the official books,” Sarrazin readily admits today. Some costs of unification were borne by social security systems, but crucially for other costs of unification a special purpose vehicle was constructed, the ‘German Unity Fund’. This allowed some of the costs of integrating East Germany to be taken off the federal budget. To the public, concerned about the costs of unification, this made the task look cheaper and more manageable than it actually turned out to be. All it did in effect, however, was to buy time and postpone the eventual payments into the future.

“The parallels between what we did then and what the European Financial Stability Facility does for Europe now are too obvious to overlook,” Sarrazin tells me. “The Europeans are buying time in the same way the Kohl government did around the time of German unification.”

It is now well known that Helmut Kohl’s initial promises that the costs of unification would be minimal and relatively short-term were as hollow as most economists at the time, including Sarrazin, had expected. Even today the direct and indirect capital transfers from West to East are about 4 per cent of German GDP, and the total fiscal transfers over the past two decades are almost equivalent to the total amount of German government debt.

Sarrazin fears that Germany’s past experiences with monetary and fiscal union could well turn out to be Europe’s future. “The EFSF gives Europe’s leaders breathing space of maybe a decade. This means that doom stories about the imminent collapse of the euro and the EU are probably premature,” he believes. “But the catch is this: At the end of the period covered by assistance measures such as the EFSF all the guarantees initially given may well be triggered. What started as a way of buying time could well end up in full fiscal union in Europe, most likely at the expense of Dutch, Austrian, Finnish and German taxpayers.”

After a decade of experience with European monetary union in practice, Sarrazin is sceptical about its future. “All attempts to legislate for fiscal stability, limited debts and no-bailout rules have not proved watertight. As it looks now, Europe is on a slippery slope towards becoming a full-blown transfer union,” he said. For someone who has first-hand experience in creating such a permanent transfer mechanism within a country, this must be a frightening prospect.

Sarrazin’s book, which had caused such a media storm, was about Germany abolishing itself through demographic change. As it appears, Europe is on its very own path of abolishing itself by embarking on a project of undermining national sovereignty and fiscal autonomy.