June 29, 2012

THE TWILIGHT OF THE BERLIN

CONSENSUS
Europe's course is slowly changing in the wake of the EU summit

by Tyson Barker

The politics of eurozone crisis-management have reached an inflection point. The Berlin
consensus that served as the guiding principle is giving way to a new center of gravity based in
the EU's Mediterranean states. The US $150 billion growth compact, agreed last week in Rome
by the leaders of the currency union’s four largest economies, is the first indication of this move.
The stimulus, roughly the equivalent of one percent of total eurozone GDP, is a clear departure
from the austerity-driven emphasis that has characterized EU crisis management since 2010.

This week’s Brussels summit continued Europe’s fundamental course correction. By allowing
direct re-capitalization of eurozone banks and the direct open-market purchase of sovereign debt
by the European Financial Stability Facility (EFSF) and its successor, the European Stability
Mechanism (ESM), European leaders took a pre-emptive step to provide the Italian and Spanish
financial systems a lifeline that can stem the vicious cycle between sovereign and bank debt.
Italy’s technocrat prime minister, Mario Monti, perhaps the chief architect of this arrangement,
has stated that Italy does not need to call upon this lifeline now. His hope is that its mere
existence will change investors’ assessment of the credibility of Italian public and private
finance.

That echoes what one senior European official said earlier this month. He hoped that market
pressure would ease once a detailed plan for mid-term crisis management was in place. Clear
benchmarks for bank and sovereign guarantees would provide markets with the certainty that
they have sought for two years. Immediate implementation wasn’t necessary, he argued. Just an
agreement would suffice.
For the Merkel government, however, the agreement reduces the certainty of its negotiation
strategy. The chancellor’s concessions regarding the ESM have elicited questions about the
decoupling of financial relief from conditionality for Europe’s financially troubled states. Some
German politicians and commentators note wryly that politics seems to imitate soccer: The
German national team’s loss to Italy reflects Berlin’s defeat at the Brussels summit. That
perception means the Merkel government must assuage domestic unease in the coming months
by shoring up previous agreements on German conditionality and advancing the German vision
for more effective eurozone governance. On both issues, however, Germany’s faces opposition,
primarily in France.

Newly elected President François Hollande campaigned on the promise to roll back even the
modest structural reforms that his predecessor had introduced, including lowering the retirement
age to its pre-crisis level. In the meantime, the new administration in Paris has already increased
the national minimum wage by two percent. The move seems modest, but it sends a signal for
higher wages throughout the French economy, which has long suffered a lack of competitiveness
vis-à-vis its northern neighbors. In addition, the Hollande government has pledged to hire 60,000
new teachers by shrinking the public workforce in other areas. But this will be difficult given the
sacrosanct position that French labor law gives to civil servants. With a debt equal to 90 percent
of its GDP, France teeters on the edge of the Reinhart-Rogoff inflection point at which public
debt has historically threatened to consume any prospect of growth. Meanwhile, the Assemblée
nationale cannot cobble together a majority to vote through the fiscal pact that the previous
government championed.

Developments in Italy, Spain and, despite being under conservatorship for the better part of two
years, Greece, reflect a similarly tenuous commitment to implementing difficult structural
reforms.

In the long run, the Franco-German fissure puts Germany’s long-term vision for eurozone
governance in doubt. For Chancellor Merkel, it’s all about the sequencing: liberalize,
democratize and, finally, mutualize. Despite her “not in my lifetime” declaration on eurobonds,
she began outlining this month an ambitious, long-term plan for a Europe whose federalization
goes beyond anything seen thus far. European Council President Herman Van Rompuy and other
EU leaders introduced a detailed roadmap reflecting this vision.

President Hollande, however, has until now summarily rejected the German sequencing and has
ruled out transferring more national power to Brussels. He also seems to be amassing allies in
northern Europe for this stance. The Dutch government has expressed its unwillingness to cede
budgetary control to a European treasury and is wavering in its commitment to the fiscal pact it
signed in December.

The Sarkozy government’s finesse minimized the Franco-German discord by acquiescing to the
Berlin consensus on austerity to buy time to iron out a common position for eurozone
governance. Today, the eurozone’s way forward is less clear. The Berlin consensus may have
fallen, but it remains to be seen what will take its place.
Tyson Barker is the Bertelsmann Foundation's director of trans-Atlantic relations.
tyson.barker@bfna.org

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