Preparing for a post-Merkel Europe

We all know that nothing lasts forever and that economic and political change is inevitable. Nonetheless, Angela Merkel’s decision on Monday not to stand again as the chair of the CDU party in December, with a view to bowing out before the 2021 election, was one of those moments when you could hear the tectonic plates shifting. Following a second consecutive poor showing for the CDU/CSU in state elections, this time in the state of Hessen, Merkel took the pragmatic view that she is part of the problem and no longer part of the solution. It takes a special kind of politician to know when to leave the stage rather than being forced out by the rest of the cast, and for that she is to be applauded.

It is also a reminder of just how much the European – and indeed global – political axis has shifted. Merkel is the embodiment of European centrism who has tried hard to keep the EU on track despite the headwinds it has faced over the past decade. Remember how she was cast as the standard bearer of responsible western values following the election of Donald Trump? Yet even she fell foul of the fault line running through western politics – immigration. It took a couple of years to make its presence felt in German politics, with the first signs evident in last year’s general election, but it has been running like a sore in France, the Netherlands and the UK for far longer.

Her anticipated departure raises a number of questions about the future direction of the EU. There is little doubt that it requires a shove in a different direction. Until now, Merkel-style German politics has supported the caravan of countries moving together at roughly the same pace. But there is increasingly a sense that this may not be what the EU needs. There is no doubt that in order for the single currency project to work requires a greater degree of integration. Some form of fiscal burden sharing would appear to be a prerequisite but it is hard to see any German politician agreeing to go down that route. Perhaps the old idea of a Europe with flexible geometry will be given a renewed hearing. This is an attempt to allow various EU countries to move towards their goal at a different pace and perhaps even with different goals in mind. It would certainly be a form of the EU that would be easier to sell to the UK which is struggling to come to terms with its EU-based schism (though too late I fear).

Whilst Merkel’s reputation amongst her opposite numbers at international forums remains high, she is less well-loved in southern Europe. German insistence that Greece deflate its economy has won Merkel few friends amongst the Greek people. It may thus be time to look again at some of the rules underpinning the single currency project. As the current spat between the European Commission and Italy has shown, a strict rules-based approach to domestic fiscal policy can lead to conflict. Despite suggestions in Germany to the contrary, Italy has actually run a pretty tight fiscal stance over the last decade, with cumulated primary surpluses on a par with Germany despite much weaker GDP growth (chart).  Moreover, as is common with most monetary unions, the euro zone struggles with the problems posed by differential external balances. With Germany running a current account surplus around 8% of GDP, this puts upward pressure on the euro and imposes significant strains on those countries that run a current deficit.

Of course, the structure of the euro zone is not specifically attributable to Merkel since it clearly pre-dates her. But Merkel assumed office in good times when the fault lines of the monetary union were nowhere near as evident as they are now, and since the single currency was working for Germany she had little incentive to push for change. However, if the single currency is to work efficiently and endure, the next few years might provide the opportunity to think about where we want to be ten years hence.

Unfortunately, I cannot see any of this happening. Emmanuel Macron has already set out his vision for Europe only to find that when it came to the crunch he got less support from Germany than he would have liked. One of the biggest seismic political shifts in recent years is the extent to which politics has become local rather than global. This probably should not be a surprise – after all, politicians are elected by their own tribe and have to do what is right for them. This makes it even more ironic that in Angela Merkel, Germany has a leader who is respected by her international peers but has been brought low by domestic issues.