FORGET about Greece, Spain or even Italy. And no, I haven’t gone mad: if somebody ends the euro, it will be Germany. This would be a great paradox. So far, Germany has been the big winner from the single currency – but it may soon find that the costs of membership are becoming greater than the benefits if it is forced to pick up everybody else’s debt. If and when that happens, and Germany decides that it has become a net loser from the single currency, the game will be up.
There are many lessons to be learnt from Germany’s reaction to the launch of the euro. It did all the hard work of regaining competitiveness, made sure its unit labour costs were under control and reduced public spending as a share of GDP. It underwent an internal devaluation: it reduced its costs the real, hard way. It also enjoyed an external devaluation: the euro is valued much lower in the markets than the Deutsche Mark would have been. Germany’s exporters have also gained immensely from the disastrous collapse in competitiveness of countries such as Italy since the euro’s launch. Germany boasts huge current account surpluses with many EU countries; its relationship with them is increasingly similar to the relationship between China (which sells goods, helped in part by an undervalued currency) and America (which buys them, and pays for them by issuing debt).
When the single currency was launched, relatively low domestic inflation compared with that seen in other Eurozone countries resulted in Germany having among the highest real interest rates in Europe – and high inflation countries enjoying the lowest real interest rates. This depressed German growth and slowly started to trigger bubbles in the likes of Spain. The German establishment soon realised that the only way to cope with such relatively high real rates was to slash costs (in the past, the Bundesbank would have cut interest rates, and this might have triggered an external devaluation via a low Mark, but with the euro and one size fits all interest rates, this was no longer possible).
As Ryan Bourne of the Centre for Policy Studies notes, Germany’s unions decided to protect jobs through wage restraint, allowing employers to capture productivity gains. This improved the profitability of domestic production and the competitiveness of German industries in international markets. A series of dramatic changes were also introduced to the labour market. Over a period of a few years in the early noughties, Germany cut taxes on company profits and capital incomes, slashed non-wage social security costs, cut regulations on temporary, agency and part-time employment, reduced benefits to the long-term unemployed, reduced the duration of unemployment benefits for older workers, diluted unfair dismissal rules and introduced a minimum income system closely tied to a requirement to look for and find work.
This was revolutionary stuff for a social democracy like Germany. The extent of the changes was greater than anything the UK coalition is doing today, albeit from a different starting point. The result was to pave the way for Germany’s recent export-driven renaissance, following thirty years of relative decline and several lean years after the botched reintegration of East Germany. All of this is highly relevant to the euro: the Germans went through change, they argue, so why can’t other countries? Germany may be a strong economy, but even it cannot afford to take on everybody else’s debt. The real risk to the euro is not Greece – it is Germany finally losing patience.
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