The Call

Think austerity is losing steam in Germany? Think again.

Think austerity is losing steam in Germany? Think again.

By Carsten Nickel

"It’s not for Germany to decide for the whole of Europe," Francois Hollande, the socialist candidate favored to win the presidential run-off, reminded Chancellor Angela Merkel on French TV last week. Gone seem the days of the "Merkozy" era when Merkel decided that austerity was the way forward out of the euro crisis — and President Nicolas Sarkozy followed suit. With much of Europe caught in recession and political opposition from Paris on the rise, the question is: Is the austerity doctrine coming under pressure in Germany? The answer is: Probably not.

A growth-versus-austerity debate has already kicked off in Germany and is set to further intensify over the next few weeks. The second round of the French elections, Greek parliamentary elections, and elections in the German federal state of Schleswig-Holstein — all held on May 6 — will amplify the pressure on Merkel. After Hollande’s strong display in the first round of the French presidential elections, the German Social Democratic Party (SPD) congratulated its French counterpart and told Merkel that it would delay the ratification of her prestige project, the European fiscal compact, because it was lacking the growth component demanded by Hollande. The chancellor, notoriously inclined to political U-turns, quickly began proclaiming growth-enhancing policies as the "second pillar" of her eurozone strategy. German commentators saw her encircled by advocates of fiscal expansion.

But the current noise should not be overestimated. Germany’s overall preference for fiscal prudence is likely to prevail because of two factors. The first is the political weakness of the opposition, providing Merkel with a strategically comfortable position at the center of German politics. The second is the country’s coordinated market economy, which prioritizes supply-side adjustments to limit wage restraint; expansionary policies would abet inflation and wage growth.

Social Democrats might perform well in the upcoming state elections, but the party’s program regarding the euro crisis remains shallow, while public support for expansionary policies stays weak. Moreover, voters have not forgotten that it was former chancellor Gerhard Schroeder’s SPD government that introduced the supply-side reforms to Germany, which Merkel now wants to prescribe to the rest of Europe. Meanwhile, the rise of the internet activists’ Pirate Party diminishes the chances for a coalition of SPD and Greens after the 2013 Bundestag elections. And the chronic weaknesses of Merkel’s coalition partner, as well as her own high personal approval ratings, provide her with much political leverage.

Merkel will pragmatically co-opt growth rhetoric over the next few weeks, and the opposition might delay ratification of the fiscal compact, both of which the SPD will sell as a success. But the party will not demand substantial growth-enhancing policies in return for their support of the compact in the Bundestag, and Merkel has already spelled out what her agenda for growth looks like: Enact labor market reforms, increase the pension eligibility age, and liberalize your economies, she told European partners. Not quite the expansionary policies many German commentators saw forthcoming.

Germany’s coordinated market economy is behind its recent economic success and its resistance to spend. In key sectors such as the automotive industry, organized workers and employers bargain without political interference. Firms offer generous welfare schemes and job security, receiving highly skilled manual workers and-crucially-wage restraint in return. Germany’s answer to rising competition from Asia has been to increase productivity in a coordinated effort. With Germans unwilling to see their export surpluses as a key factor behind the eurozone’s woes, their preference for austerity is here to stay.

Carsten Nickel is an analyst with Eurasia Group’s Europe practice.