An alternative perspective

11 March 2015

Europe's Rough Road Ahead

In 2015, Germany will take the next steps towards becoming the dominant power in Europe. In many ways, this is good news because Germany is as sturdy, politically and economically, as any country in the world. It is a country in which the consensus view is that prosperity depends on peace and stability. Bills must be paid. Credibility is crucial. At a moment when Europe’s difficult reform process remains unfinished, when euroscepticism is rising across the continent, as turmoil in the Middle East threatens attacks by Islamic militants on European capitals, as Russia creates crisis at the EU’s eastern boundaries, Germany remains an island of stability.

Yet, there is little doubt that the collision between Angela Merkel’s government and the rising tide of anti-EU sentiment in Europe will generate a new level of friction in 2015. As pressure increases from Berlin (and Brussels) for more belttightening in the periphery, as growth sags and unemployment continues in many European countries, and as public anxiety over the economic and security implications of open immigration take a toll, Europe’s politics are reaching boiling point.

A new wave of challenges is set to break. In Greece, Syriza, a party of the far left, has pushed its way past establishment parties to form a government – and the neo-fascist Golden Dawn finished a strong third. Fears of a Greek exit, though exaggerated, will roil markets in coming months. However strident their public statements on the matter, Syriza, Merkel and the ‘troika’ will work towards a compromise on plans to keep Greece within the Eurozone. Greece’s new government does not want the blame for a full economic collapse. Berlin and Brussels are not eager to test the theory that damage caused by a Greek exit from the euro can be contained. But negotiations towards an agreement won’t be easy. Syriza can’t be seen to cave into European demands that Greece swallows yet more bitter medicine. Germany and the troika can’t offer Greece a generous deal that will induce Spain’s government to drive a harder election year bargain on further financial aid. Italy and France, two countries that are too big to bail, are watching as well.

In Spain, Podemos, like Syriza a party of the left, is on the rise and could enter government by the end of this year. In Italy, the Five Star Movement continues to make noise. In the UK, the rising popularity of the UK Independence Party (‘UKIP’) will ensure that the UK’s Conservatives keep their distance from EU politics ahead of national elections in May. France’s right-wing Front National is polling ahead of the traditional left and right. Even in Europe’s strongest state, the euro-bashing ‘Alternative for Germany’ is making its presence felt. For Europe-wide policymaking, Germany has no rival. But a weak France, an absent Britain, preoccupied Italy and angry periphery may leave many Germans wondering whether the country’s growing pre-eminence will be good for Germany or for Europe.

German Flexibility?

Europe’s political imbalance has been growing for many years, but it has accelerated since the Eurozone debt crisis which lifted Germany to its current position as Europe’s economic hegemon and key creditor state. It is Germany, in the person of Chancellor Merkel, who has acted as central mediator between the governments of Russia and Ukraine. Germany also exercises greater influence in European institutional governance. The ascendance of Jean-Claude Juncker as President of the European Commission Donald Tusk at the European Council, and Federica Mogherini as Europe’s new foreign policy czar came with the implicit blessing of Germany.

France, by contrast, is quickly losing clout. Before the terrorist attacks in Paris in early January, President François Hollande registered an approval rating of 13 per cent, the lowest ever rating for an incumbent French president. His Socialist Party is deeply divided. The opposition UMP is preoccupied with battles for leadership. In Britain, Prime Minister David Cameron will continue to contend with a rebellious Conservative right wing that wants to remove the UK from the EU. Italian Prime Minister Matteo Renzi is fully focused on domestic reform.

The result of this imbalance is an inability to change direction in European policy that can satisfy growing public demand for change. The European Central Bank’s (‘ECB’) bold move in January towards quantitative easing will boost consumer and investor confidence in the near term, but Germany will likely work hard to ensure that member states don’t try to amplify the effect with a more expansionary fiscal policy, limiting the likelihood that the ECB can help the Eurozone recover. Merkel has no good reason to alter course. Her top priority for the year ahead will be to deliver the ‘black zero’, a balanced federal budget, and every other economic goal will be subordinated to that, despite slowing economic growth and fears that the euro area is drifting into deflation. Fiscal discipline at home will create demand among German voters for fiscal austerity abroad, and no significant EU-wide stimulus is likely. Over time, Germany’s bitter medicine may yield positive results, but it won’t help European growth or political stability in 2015.

Germany’s crisis policies will be tested in the southern periphery in 2015, especially in Greece and Spain. While both countries’ front-loaded economic adjustments have brought positive results, evident in Greece’s primary surplus and Spain’s positive growth forecasts, these have not yet translated into material improvements in people’s lives. More than six years after the euro debt crisis began, unemployment remains above 23 per cent in both countries, and at record levels among both the young and long term jobless. In 2015, this will translate into fragmented national parliaments, a continued rise in populism, and a generalised distrust of European politicians and the European project.

Euro-Gridlock

With limited political appetite for ‘treaty change’ – a shift in the balance of power and competences between institutions in Brussels and the EU’s member states – any reforms will remain limited in depth and scope. There will be no completion of the EU’s ‘banking union’ to complement Eurozone-wide bank supervision and resolution with deposit insurance. There will be no transfer of wealth from north to south in the form of fiscal transfers, a mutualised debt instrument, an expanded EU budget, or full fiscal union that might ease the pain of continued austerity in Greece and Spain. With an incomplete institutional architecture, the Eurozone will remain susceptible to economic and, perhaps more importantly, political shocks throughout the year.

Trouble on the Door Step

Then there are the foreign policy challenges. The showdown with Russia will escalate in 2015. For the moment, President Vladimir Putin’s popularity depends less on Russia’s long-term economic dynamism than on Putin’s aggressive attitude towards confrontation with the West in general and the US in particular. Lower oil prices, which are likely to continue for at least the first half of 2015, and the impact of Western sanctions have imposed enough pain on Russia to make Putin angry, but not enough to make him more cautious. The violence in eastern Ukraine will continue, because Moscow believes it can destabilise the government in Kiev by forcing it to spend borrowed money on a war it cannot win.

As a result, US and European sanctions on Russia will continue – and could intensify – and these sanctions will weigh on Europe’s recovery. As Europe’s economic growth slows during the year, the German-led tough approach to Moscow will generate more anxiety among those Europeans most worried over the sanctions’ impact at home. That will also add to the deterioration of transatlantic unity at a time when anti- American attitudes are rising in Europe over US spying.

Making matters more complicated, as the recent attacks in Paris remind us, Europe is more vulnerable to terrorist threats from Islamist militants than any region outside the Middle East, given the number of European citizens fighting in Iraq and Syria, and the size of Muslim communities now living in Europe. No country is more vulnerable than France, but open borders within the Schengen Area give rise to anxiety and anger over immigration and security threats in a growing number of EU member states.

A wise leader knows that a crisis must never be wasted and Europe’s leaders worked together at the height of Europe’s debt crisis to avoid catastrophe. The ECB, Germany’s leaders and the governments of southern-tier countries like Italy, Spain, Portugal and Greece have demonstrated vision and courage to guide Europe through a dangerous storm over the last few years. But the work is not finished and a growing number of election results signal that public frustration is on the rise.

That is why 2015 will be such an important year for Europe – and why optimism about German leadership and Europe’s future is increasingly hard to come by.

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