European eyes on German elections

In: Uncategorized

12 Jun 2013

This is my cover story on the upcoming German elections for Fund Strategy magazine. The associated graphics can be found here.

The German elections on 22 September are likely to be important for the whole of Europe. Whatever the complexion of the new government, it will play a central role in deciding the future shape of reformed institutions in the European Union.

In that respect, the federal elections of 2005 or even 2009 were not nearly so notable. Although they were a democratic exercise for German citizens, they did not have substantial consequences beyond the country’s borders.

It is only in the last few years, with the emergence of the euro crisis, that Germany has come to the fore. For example, it was only in December 2009, more than two months after the last federal elections in Germany, that Greece conceded its debts had reached record levels. Since then, other eurozone member states – most notably Greece, Ireland, Portugal and Spain – have all suffered well-publicised difficulties.

Georg Grodzki, the head of credit research at Legal & General Investment Management, says: “You now have so many more initiatives, proposals and actions on the agenda which were simply taboo only four years ago.

“The whole arsenal of intra-eurozone crisis management tools – country bailouts, rescue mechanisms, guarantees, banking union, ECB [European Central Bank] bond market interventions – neither existed nor would it have been considered legal and possible.”

Germany has come to play a central role in tackling these problems. Andrew Milligan, the head of global strategy at Standard Life Investments, says: “Germany is now very clearly the paymaster-general for Europe. It is in charge of the speed with which the European project goes and to a certain extent it can determine the direction. European banking union will largely be determined by what the Germans want.” This is likely to be even more the case in the next few years as the eurozone attempts to move towards closer fiscal integration and banking union.

Paradoxically, it does not necessarily follow that the eurozone will be a central theme of the election itself. On the contrary, the last thing the main German political parties want is to have a heated public debate on the subject. From their perspective such a discussion could be highly divisive as it could expose deep divisions among the German population.

For that reason, the German establishment is doing all it can to quieten down discussion on the topic. Milligan says:

“Mrs Merkel will want a very quiet 2013 as that puts her in the best possible position to win the election.”

Seema Shah, a global bond strategist at Principal Global Investors, goes a step further. “If anything, 2013 has been a quiet year for the European bond markets precisely because of the German elections. If anything were to kick off this year Germany would not take a strong position for or against,” she says.

Other eurozone member states, as well as EU officials in Brussels, are happy to go along with the trend to keep quiet about the region’s structural problems. The last thing they want to do is to upset their paymaster in Berlin.

However, there is a chance that the eurozone will become a focus for debate despite all the efforts to keep quiet about it. A new political party, the Alliance for Germany (AfD), is campaigning on an anti-euro ticket. Although the established parties are doing all they can to play down its significance, there is a chance it could win a substantial protest vote. If it wins seats in the election, it will probably be harder for the incoming government to constrain discussion on the merits and demerits of the eurozone.

To assess the significance of the September elections, not only for Germany but, more broadly, this article will examine three key themes. First, the discussion of the eurozone and reform of the EU more generally. Second, the debate about what is often referred to as “social justice” or “social cohesion”. This brings in topics such as curbs on executive pay, raising income tax and even a possible wealth tax. Finally, it will consider the debate about financial institutions themselves. For those who are new to discussing German politics, there is also a guide to the main political parties and a piece on the German approach to economics.

EU reform

Although Germans are generally supportive of the EU, they are not universally favourable. A recent poll by Pew Global Research, a non-partisan American organisation, found 60% of Germans are in favour of the EU compared with 43% in Britain and 33% in Greece although 68% of Poles expressed a positive view. However, German support was substantially down on 2012, when 68% of those questioned were favourable.

If anything, the opinion among the mainstream parties differs less than among its citizens. As Kevin Lilley, the manager of the Old Mutual European Equity fund, noted in a written statement: “Germany has a consensus-driven political system and the left wing is even more pro-European than the right and has generally supported the current government’s actions.”

One area on which the parties have differed is eurobonds – that is bonds issued jointly by eurozone member states. In 2010, Peer Steinbrück, now the opposition Social Democrat (SPD) candidate for chancellor, co-wrote an article in the Financial Times in which he supported such instruments (“Germany must lead fightback” FT 14 December 2010). However, more recently, he has played down such initiatives. Clearly, they could potentially exacerbate German fears that it could end up paying a high price for bailing out others.

In contrast, the Free Democrats (FDP), the junior partner in the Christian Democrat- led coalition, is strongly against such debt mutualisation measures. It has resisted the idea of eurobonds as well as that of a common debt redemption fund.

Shah does not see any prospect of eurobonds being introduced in the foreseeable future. “I do not envisage anything such as a debt redemption fund or eurobonds coming in in the next few years at all,” she says. “It does not matter who wins.”

That is not to say that an SPD-led German government would necessarily be seen as a soft touch by other eurozone member states. It might be less strict on fiscal deficits but it could be more stringent in other ways. For instance, it was the SPD along with the Greens that first demanded a bail-in of bank depositors in Cyprus. They took this position on the grounds that they were against the bailing out of Russian oligarchs.

Perhaps the biggest wild card in the election is the AfD. If it becomes a vehicle for public discontent, as the Five Star Movement did in Italy, it could cross the 5% threshold and win seats in the lower house (Bundestag). However, even if it got, say, 2-3% of the popular votes, there is a chance it would take support disproportionately away from the current coalition parties.

Although the emergence of a eurosceptic party is a radical departure for Germany, the AfD is more technocratic than populist. Much of its core membership consists of fiftysomething economics professors rather than street protestors. It calls for an orderly break-up of the euro rather than the abolition of the EU.

Social justice

On the face of it, the SPD and Greens should do well in the elections with their emphasis on social justice and maintaining social cohesion. According to the Pew Global Attitudes survey, no other Europeans place as much emphasis on reducing inequality as the Germans. Some 51% of Germans said it was their main concern in the poll.

This is perhaps strange given that the German economy and labour market are performing relatively well. According to a recent survey by the Organisation of Economic Cooperation and Development, a rich country think tank, earnings are increasing and poverty is falling. Germany’s unemployment rate is also low compared with other European countries. To the extent there is concern it focuses largely on such topics as sluggish economic growth and skyrocketing rents.

Nevertheless the SPD is committed to at least mitigating the extremes of inequality. In its election platform, it calls for an increase in the top rate of income tax as well as a statutory minimum wage. The Greens go even further in the direction of redistribution with support also for a wealth tax and increased inheritance tax.

Not that the CDU is entirely hostile to redistribution. Merkel has voiced support for measures to curb top manager salaries although she is opposed to any wealth tax.

It would also be a mistake to take the Spud’s apparently left wing rhetoric at face value. It was an SPD-led “red-green” government under Chancellor Gerhard Schröder that introduced the Agenda 2010 programme in 2003. The initiative made it easier for employers to fire workers as well as reducing entitlements to unemployment benefits.

This then is another area where the differences between the parties are not as great as they first appear. Although the SPD and Greens place more emphasis on redistribution than the conservative parties, they have taken a leading role in promoting a more flexible labour market. Meanwhile, the CDU is willing to criticise high executive pay when it is widely regarded as excessive.

Banking and finance

The banking sector, and financial markets more generally, have both practical and symbolic value in the election.

As with social justice, it is the SPD that takes the lead in criticising the banks. What the party calls “taming financial capitalism” is central to its programme. As Sigmar Gabriel, the party chairman, wrote in the Guardian in March: “The real root of the [economic] crisis does not lie with profligate governments. Rather, it was excessive speculation and the resulting crash that forced many states to go massively into debt to bail out their banks.” (“German Social Democrats’ twin goals of social justice and banking reform”, Guardian, 14 March 2013 ).

This argument leads it to proposals for extensive reform of the banking system. It favours stricter capital adequacy requirements, a reduction of proprietary trading and the introduction of a financial transaction tax. It also supports the creation of a separation between commercial and investment banking.

The problem is that it did not attempt to introduce such measures when it was in office. To its critics its arguments can seem like opportunistic posturing.

It talks radical by criticising the conservatives when they are in office but is reluctant to take action itself.

Of course, this does not stop the SPD trying to take advantage of tax scandals. When Ulli Hoeness, the president of Bayern Munich Football Club and in Germany’s 1974 World Cup winning team, became embroiled in a tax scandal, both the CDU and the Christian Social Union (CSU), its Bavarian sister party, distanced themselves from him. The two parties had until then maintained friendly links with the football icon.

However, banking reform is hardly a theoretical topic in relation to the debate about the future of the eurozone. On the contrary, it is widely viewed as central to any programme of European economic integration.

As things stand, the plan is to introduce banking union in three stages. First, there will be the introduction of common supervision in which the ECB will take on responsibility for regulating banks across Europe. The plan is for this to start in July 2014 although it is still unclear how extensive the scope will ultimately be.

It could end up with the ECB directly supervising only a few large banks or it could go a lot further.

The next stage is a single resolution mechanism. This would provide a way to deal with banks that got into serious trouble. However, in April, the CDU finance minister Wolfgang Chasuble suddenly argued that introducing this step would require treaty change within the EU. If Germany holds to this line, it will inevitably mean slowing down the process of banking union.

Finally, there is the question of a common deposit guarantee scheme. In a truly integrated eurozone, a pan-European scheme would protect depositors from all member states. Yet it is hard to see this stage going ahead until the single resolution mechanism is sorted. On paper, the SPD and indeed the Greens too are more amenable to banking union. Both parties have expressed support for a European-wide resolution fund. But it would not be surprising if they toned down such support if they were elected into office. They are certainly sensitive to the charge that hard-working Germans should have to bail out allegedly lax southern Europeans.

Such concerns are part of what Ulrike Guérot, the senior policy fellow at the European Council on Foreign Relations in Berlin, refers to as the “paymaster victimisation discussion”.

Germany is keen on European integration in the abstract but is reluctant to pay the price. “Germany is not prepared for what needs to be done,” she says. “So it delays the whole thing.”

The most likely outcome of the Sept-ember elections is another CDU-led government. A grand coalition including both the CDU and the SPD is also a distinct possibility. But whoever is victorious could be facing tumultuous times in Europe in the years ahead.

[Box one] Political parties

Christian Democratic Union (CDU) The senior party in the current coalition government. Conservative in outlook. Leading figures include Angela Merkel and Wolfgang Schäuble, the finance minister. At the time of writing, the party was well ahead in the opinion polls.

Christian Social Union (CSU) More conservative Bavarian sister party of the CDU. Led by Horst Seehofer, who was previously a minister in Merkel’s cabinet and is now the premier of Bavaria.

Free Democratic Party (FDP) Also known as the Liberals. The junior coalition partner in the current CDU-CSU government. Own the centre-right and pro-business. There is a chance it will not receive the 5% of votes necessary to win seats in the Bundestag (lower house).

Social Democratic Party (SPD) The main opposition party. The centre left organisation recently celebrated its 150th anniversary although it has travelled far from its hard left roots. Its candidate for chancellor is Peer Steinbrück who served as finance minister from 2005 to 2009.

Greens (die Grunen) The most important green party in Europe. Served as part of the governing “Red-Green” coalition with the SPD from 1998-2005. However, it has formed coalition governments in regional states (Länder) with the CDU and the FDP. Led by Claudia Roth and Cem Özdemir.

Left Party (die Linke) Its roots can be traced back partly to the ruling party of the old Stalinist East Germany regime and partly to disgruntled former SPD members. Led jointly by Katia Kipping and Bernd Riexinger.

The Pirates (die Piraten) The party, founded in 2006, received about 2% of the votes in the 2009 national elections. Its main focus is on freedom of information. Appears to have passed its peak of support.

Alternative for Germany (Alternative für Deutschland – AfD) New eurosceptic party led by Bernd Lucke, an economics professor in Hamburg. Advocates a gradual dissolution of the eurozone although it does not call for a German exit from the European Union. Could appeal to protest voters who in the past might have voted for the Greens or the Pirates.

The composition of the Bundesrat (upper house) is determined by the 16 Länder governments so its composition changes with regional elections.

[BOX two] German economics

One reason for the frequent tension between Germany and other members of the eurozone is the significantly different economic outlook held in German governing circles. Germany tends to place more emphasis on monetary stability and balanced budgets than other European countries.

This difference is routinely explained as a hangover from Germany’s experience of hyperinflation in the early 1920s. Media discussion of German attitudes towards inflation is typically illustrated with old photographs of people carrying worthless piles of banknotes in wheelbarrows.

The problem with this explanation is that hardly anyone alive today can be old enough to remember events of 90 years ago. Although the experience of economic dislocation in Weimar Germany was undoubtedly traumatic, it was a long time ago.

Although there is a link between the current discussion and Germany’s economic past it is not as straightforward as a folk memory of hyperinflation. It is better understood in relation to the extreme fear of instability that imbues the German elite. The resultant emphasis on order applies as much to economics as other aspects of Germany life.

What is sometimes called Ordoliberalism emerged in German in the 1930s. It can be seen as a conservative response to the economic experience of the 1920s and the excesses that were already apparent in the early days of Nazism.

Its founders, including Franz Böhm, Walter Eucken, Hans Großmann-Doerth and Wilhelm Röpke, were wary both of excessive state power and unchecked markets. Like classical liberals they believed in the importance of markets but unlike them they saw the state as playing a key role. For instance, the role of the state was not just to ensure exchange could take place but also to prevent the emergence of powerful monopolies. It also had to create and police a framework of rules for economic actors to follow.

With the emergence of the Federal Republic after the Second World War, the ordoliberals came to play an important role in devising what came to be called the social market economy (Soziale Marktwirtschaft). They influenced the thinking of Ludwig Erhard (CDU), who was West Germany’s first finance minister and later became chancellor. Essentially a degree of income redistribution and social safety nets were added to the idea of a highly regulated market economy.