A failed euro would define Merkel’s legacy

Berlin should think beyond short-term damage control and push its European partners to commit jointly to much-needed EU reforms

The breakdown of negotiations on Greece has come as a shock. [On Tuesday, Greece missed the deadline for a €1.6 billion payment to the International Monetary Fund, hours after Eurozone ministers refused to extend its bailout.] Berlin and other European capitals look in disbelief at the Greek government’s resolve to inflict huge economic and financial damage on its own country and its citizens.

But Greece will not be the only loser. The stakes for the German government are high, both domestically and internationally. Yet Berlin has a rare window to use the present Greek tragedy to push for the implementation of urgently needed reforms, thereby making the euro sustainable and giving European integration again a stronger legitimacy.

Across Europe financial market risks are likely to be tremendous in the coming days and weeks. The most immediate challenge for Eurozone governments is damage control. The risks from contagion have repeatedly been downplayed. But no one can reasonably predict whether and how the crisis will spill over from Greece.

Many Eurozone economies are still vulnerable. Italy’s economy has shrunk 10 per cent since 2008, while sovereign debt has increased to about 135 per cent of gross domestic product.

The European Central Bank had to intervene in July 2012 to promise to do “whatever it takes” in order to protect the integrity of the Eurozone and prevent a sovereign default of Italy and others. The most likely scenario for the immediate future is that Europe’s politicians will again hide behind the ECB, hoping that it will do the heavy lifting to prevent market turmoil and stabilise the Eurozone economy.

But what is at stake is not only economic and financial stability. The long-term political damage could be devastating, in particular for the German government. The blame game is heating up about not only who is responsible for the Greek tragedy but why the Eurozone failed to get its act together over the past five years and end the crisis. This is a game Berlin and Angela Merkel, Germany’s chancellor, can hardly win. As the strongest economic and political member of the Eurozone, Europe and the world have been looking to Berlin to solve the crisis and to reform Europe.

Sure, Merkel may have done the right thing in the negotiations trying hard to broker a deal and making significant concessions to the Greek government. Short of capitulating, she had no chance of succeeding with this Greek government. But this will be no more than a footnote in history.

What is at stake for the German government is no less than its credibility, both at home and internationally. It promised its citizens a more stable Europe in exchange for financial help. It promised them to not accept any haircut on its loans, a promise it now has to renege on. Merkel’s declaration that “Europe fails, if the euro fails” is correct, but it might come to haunt her and shape her legacy as chancellor. Germany’s many critics now feel vindicated. This feeling would be even stronger if Greece left the euro and returned to its national currency.

Binding rules

Still Berlin has a chance to turn the tables and transform the Greek disaster into an instrument to push for much needed reforms of Europe, and hence a stronger Eurozone. The most important policy decisions over the past decade were taken under duress and in times of crisis. Governments and central banks stabilised global markets through their joint declaration at the G20 meeting in New York in 2008. The decision to pursue the European banking union was made at the height of the European crisis in June 2012.

The so-called five presidents’ report from the heads of the main European institutions, released last week, contains many of these elements. This includes a fiscal union, with credible and binding rules, and insolvency mechanism for states and a joint fiscal capacity. This would not only provide protection for individual countries, but also smooth economic fluctuations and allow countries to reap the full benefits of the common currency for euro area members and of the single market for all EU countries. Such reforms will require changes to the EU treaties. This would allow Germany to also look beyond the Eurozone to the concerns of the UK, which are widely shared in Berlin.

Berlin should think beyond short-term damage control and push its European partners to commit jointly to muchneeded reforms of EU institutional architecture. This should include a stronger fiscal union, capital market union and treaty change also to avoid a British departure from the EU, the so-called Brexit, which would be an even greater tragedy for Europe than the Greek crisis.

This may be the only chance for the German government to protect both its credibility and legacy in Europe.

Marcel Fratzscher is president of DIW (German Institute for Economic Research) Berlin, a think-tank.