Charles Kindleberger, the preeminent historian of financial crises, described a hegemon as a country willing to accept short-term costs for the sake of promoting international financial stability. The hegemon’s ability to absorb these costs allows it also to set the agenda – a responsible hegemon must lead by helping establish internationally acceptable rules.
In the eurozone, Germany is the only country standing. Of the other so-called core countries, the Netherlands is struggling to overcome its financial excesses. France is embarked on long-term economic decline with little margin to support Europe – indeed, France is edging toward debtor status.
Although still standing, the blunt reality is that even Germany does not have the economic and financial strength to either spur European growth or to underwrite a financial stability net. Not surprisingly, therefore, the political pushback is vehement when Germans are called on to do more for Europe. But Germany does have a crucial role: to redirect European governance to overcome the gaps revealed by the crisis. Because its voice counts for more than that of others, Germany’s responsibility is correspondingly great.
Germany has never been an economic locomotive for Europe. The German economy responds to the movements of the global economy, performing with great vigor when global trade is strong. When German exports to the world grow, Germany transmits the global impulses by stepping up its imports from other nations. But because German domestic consumption and investment largely respond to these external movements, Germany does not generate its own impulse to invigorate growth elsewhere.
For this reason, other nations have demanded greater German fiscal stimulus to accelerate the German economy and, thus, increase imports from – and, hence, raise growth in – the struggling European nations. During the critical years, 2008-2010, Germany participated in a globally-coordinated fiscal stimulus that proved essential to pulling the world economy back from the abyss. Since then, Germany – and other major economies – have turned fiscally conservative. Germany’s fiscal space is not evidently greater than that of other advanced nations. But even if a German stimulus could be engineered, studies show that the spillover benefits to the rest of Europe – particularly to its most distressed parts – would be small.
These considerations are particularly important in view of German’s recent lackluster economic performance. As world trade rebounded from its precipitous fall in 2009, Germany responded robustly. Chinese demand was especially strong and German companies were well-positioned to take advantage of the opportunities. Germany seemed poised for another miracle. Since then, the global economy has slowed, and world trade is crawling at 2 percent a year. Even the dynamic emerging markets are slowing. Germany has avoided the recession in which much of the eurozone is mired, but the problems elsewhere in Europe are weighing on Germany. This drag is likely to persist.
And, yet, the direction Europe takes rests crucially on the energy and style of German leadership. Writing nearly 30 years ago, the former German chancellor, Helmut Schmidt, called for a cooperative framework to preserve and consolidate the Atlantic alliance. He complained that the United States saw its role as presenting Europe with fait accomplis. He lamented: “…dependency corrupts – and corrupts not only the dependent partners but also the oversize partner who is making decisions almost single-handedly.” The challenge is to achieve a decisive move forward but one that respects national sovereignties.
The recent German proposal for a banking union is, in this light, intriguing. It is a small –but foundational step – in the right direction. The ongoing efforts for common bank resolution and deposit insurance are stymied because they require the ceding of fiscal sovereignty, which, Finance Minister Wolfgang Schaeuble has cautioned, is inconsistent with existing treaties. More importantly, the political willingness to take that leap is absent. Giving up fiscal sovereignty is tantamount to a political union, which cannot be done through the back door.
Instead, the German proposal offers a practical way ahead – but Germany must lead by example. Member countries would agree to and enforce common standards on bank resolution and deposit insurance. This works if the standards for financial oversight and discipline are truly rigorous. The incentives today for preserving the status quo must be replaced by a push to proactively shut down the growing corpus of zombie banks and by bolstering the viable banks with greater capital and liquidity buffers. Healthy banks and growth support each other.
If Germany is to lead, it must apply these principles to its own troubled banks and shed its reputation for diluting the new generation of international bank regulatory standards. That would be good for Germany and for Europe.
* Ashoka Mody is a visiting fellow at the Brussels-based think-tank Bruegel and a visiting professor at Princeton University. He was formerly the IMF’s mission chief in Germany and has recently edited the “The German Economy in an Interconnected World Economy.”