The Flaw in the Merkozy Plan European politicians just don’t get it, do they ?

You’ve got to pity the Germans; no-one ever seems to feel sorry for them. After all, the reintegration of East Germany after the collapse of the Berlin Wall twenty-two years ago cost the country €1.3 trillion. Uniquely in Europe, Germany then spent a decade diligently and laboriously working on increasing its labor productivity and reducing labor costs, reforming public finances, and getting its financial house in order, unlike many of the other Eurozone countries that splurged on pay raises for civil servants and white elephant public construction projects. It now has the healthiest economy in Europe after the Netherlands and a massive trade and budget surplus. So why is everyone now expecting that Germany bail out the peripheral Eurozone countries that were so profligate over the same period? It just doesn’t seem fair. This at least, is the current Weltbild from Berlin and Frankfurt, and it is clearly reflected in the measures contained in the new 26 country EU treaty announced by the Merkozy team on December 9. Germany sees the Eurozone crisis as a debt problem uniquely anchored in the fiscal irresponsibility of politicians in other countries of the monetary federation, and it contrasts its own growth and healthy trade surplus with the stagnation and trade deficits in the other countries. Now that the chips are down, Germans just don’t think it’s fair that their country would be expected to pay for resolving the crisis. They believe that Greece, Italy, Ireland, Portugal and Spain need a good dose of fiscal austerity; they need to roll up their sleeves and become competitive, just the way Germany did ten years ago. The new treaty is a compact to enshrine responsible fiscal management in Europe. To my mind, the German view of the financial crisis is deeply flawed, and the harsh medicine that Germany and France think will purge the wrongdoers of their sins is likely to kill the patients before it cures them. Indeed, it is likely to bring the entire Euro structure tumbling to ruin. This is not to say that the troubled Eurozone peripheral countries – Portugal, Ireland, Italy, Greece and Spain (the PIIGS) – are blameless. Greece in particular racked up unsustainable public debt and a persistent budget deficit and has had to engage in debt restructuring with its lenders because it’s simply not able to service its debt mountain. Ireland and Spain allowed housing bubbles to develop that significantly weakened these countries’ financial sectors when private borrowers were unable to pay their mortgages, and their banks eventually had to be bailed out. Italy has an over-regulated economy, one that is rigid, uncompetitive and unfriendly to business, which has held back economic growth and the country’s ability to service its huge debt. Portugal is a less exuberant Greece, with public spending projects and a social safety-net that the country simply can’t afford. All of these countries were negligent, for unlike Germany, it’s true they did not invest in productivity improvements, they did not improve competitiveness, and they did not clean up their public finances. But nevertheless it’s difficult not to feel that countries like Spain, whose debt to GDP ratio has been similar to that of Germany, are getting a raw deal. Nonetheless, the crisis is much more complex than the simplistic view from across the Rhine. It is more like a set of Russian Matryoshka dolls, those intricately painted and lacquered wooden figurines nested one inside the other. The largest, most visible doll is the debt crisis. It towers over us, and is in some ways a self-fulfilling prophecy. As we saw with both Greece …