The fallout from Merkel’s waning power

Published in Business Spectator (Melbourne), 26 June 2014

For the past four years, German Chancellor Angela Merkel has topped Forbes’ list of most powerful women. She was actually ranked first on that list for nine out of the last ten years, not least thanks to her pivotal role in the European debt crisis. It is debatable whether Merkel actually managed to negotiate good deals for her country, but at least it always appeared as if she was able to dictate her will in Europe.

Not anymore.

The aftermath of the European Parliament elections sees the German Chancellor in a highly unusual position. For the first time, Merkel does not even seem to control developments in Europe anymore. This is obviously bad news for her, but it is even worse news for Europe’s long-term prospects. As Merkel’s influence declines, so do the chances of fiscal consolidation.

There are several reasons for Merkel’s troubles. The first is her coalition partner at home. As I predicted straight after her election victory last year, forming a government with the Social Democrats would weaken her ability to demand austerity policies in Europe (Merkel’s victory will blunt her sword, September 26, 2013).

When she still governed with the Free Democrats and a small parliamentary majority, Merkel had to take eurosceptical rebels into account. This meant that she had to appear tough, demanding reforms and austerity in return for German support to ailing European economies. Now, in a Grand Coalition with the Social Democrats, no such consideration is necessary.

On the contrary, her Social Democrat deputy, vice-chancellor Sigmar Gabriel, is openly questioning the wisdom of austerity policies. Gabriel is quietly shifting Germany away from its previous insistence on fiscal consolidation across Europe, siding rather with fellow left-of-centre leaders such as French President François Hollande and Italian Prime Minister Matteo Renzi than with his coalition partner Angela Merkel.

The second reason for Merkel’s weakness is Jean-Claude Juncker. The leading candidate of Europe’s centre-right parties in the European Parliament elections was never Merkel’s favourite. In fact, Merkel did not even like the idea of having candidates for the presidency of the European Commission in the first place. However, when Europe’s Social Democrats nominated Martin Schulz for the job, the centre-right had no chance but to nominate a candidate themselves.

Merkel could do nothing to stop nominating a candidate for President, and then she could not stop Juncker’s nomination.

When it comes to Europe, Juncker stands for everything Merkel does not. Not only does he believe in a much more politically integrated Europe than Merkel would ever envisage, but Juncker has also argued for eurobonds (jointly issued bonds by Europe’s national governments) which Merkel has ruled out categorically “for as long as I live”. The former Luxembourg premier is no fan of austerity policies or fiscal rules. Instead, he favours greater wealth transfers between European countries.

It was obvious that Merkel was not comfortable with the outcome of the European elections. Her European People’s Party may have become the strongest party in the European Parliament, but especially since the Social Democrats are supporting him, it now looks impossible to avert Juncker’s rise to the presidency of the European Commission.

That in itself would be bad enough for Merkel but as further collateral damage, she now stands to alienate her most reliable ally in Europe, British Prime Minister David Cameron — the third reason for Merkel’s troubles. Cameron, under threat from eurosceptics in his own party and UKIP, is even more opposed to Juncker than Merkel. He has made his opposition public, even hinting at Britain leaving the EU if Juncker got elected, but could now be humiliated if Juncker gets the top job regardless. It would weaken Cameron both at home and in Brussels — and rob Merkel of a key partner for fiscal discipline in Europe.

The fourth reason for Merkel’s problems are the political leaders of France and Italy. France’s President Hollande is with his back to the wall after his first two disastrous years in the job and with dismal polling results. Meanwhile, Italy’s new Prime Minister Matteo Renzi won an emphatic victory in the European elections. Though their political fortunes could not be more different, Hollande and Renzi are united against further austerity policies. They both argue that a relaxation of fiscal rules are a necessary condition for economic reform.

The political conditions to demand such a change of direction are excellent. Not only can Hollande and Renzi count on the support of Merkel’s coalition partner in Berlin, Sigmar Gabriel. They also know that Merkel’s candidate for the European Commission, Jean-Claude Juncker, agrees with them. And they could even try to negotiate their vote for Juncker in return for an end to austerity.

With all of these developments going against her, Merkel is about to give in. Her spokesman just announced that there could be ‘flexibility’ in the application of the rules laid down in the European Stability and Growth Pact. Not that anyone ever really played by its debt and deficit rules in the first place.

In the future, even more creative accounting could be possible. The French, for example, would like to see government spending on energy policy, research and development excluded from calculating the budget deficit. It is a budgetary trick which would make their country’s deficit seem smaller than it actually is.

Unsurprisingly, such considerations have alarmed proponents of fiscal consolidation such as Bundesbank President Jens Weidmann. In an opinion editorial on Tuesday, he warned that any further deviation from the rules of the Stability Pact could see a return of the euro crisis and undermine trust in the common currency.

Weidmann may well be right. However, Merkel’s standing is so weakened both domestically and internationally that she will be struggling to heed such warnings. The days when Merkel, allegedly the most powerful woman in the world, could dominate European decision-making, are over.

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