The End of German Hegemony
Daniel Gros
16 October 2015
Without anyone quite noticing, Europe’s internal balance of power has been shifting.
Germany’s dominant position, which has seemed absolute since the 2008 financial crisis,
is gradually weakening – with far-reaching implications for the European Union.
Of course, from a soft-power perspective, the mere fact that people believe Germany is strong
bolsters the country’s status and strategic position. But it will not be long before people begin to
notice that the main driver of that perception – that Germany’s economy continued to grow, while
most other eurozone economies experienced a prolonged recession – represents an exceptional
circumstance, one that will soon disappear.
In 12 of the last 20 years, Germany’s growth rate been lower than the average of the other three
large eurozone countries (France, Italy, and Spain). Although German growth surged ahead
during the post-crisis period, as the graph shows, the International Monetary Fund predicts that it
will fall back below that three-country average – and far below the eurozone average, which
includes the smaller high-growth countries of Central and Eastern Europe – within five years.
To be sure, Germany still has some apparent advantages. But a closer examination shows that they
are not quite as positive as they seem.
For starters, Germany is close to full employment – in sharp contrast to the double-digit
unemployment rates that prevail in much of the eurozone. But the combination of full
employment and low growth rates actually points to an underlying problem: very slow
productivity growth. Add to that a shrinking pool of workers capable of meeting the needs of
Germany’s labour market – the country’s population is aging, and the arriving refugees lack the
needed skills – and the German economy seems set for a protracted period of sluggish
performance.
Another apparent advantage is Germany’s large financial reserves, which not only cushioned it
from the crisis, but also conferred upon it considerable political sway. Indeed, because German
funds were indispensable in bailing out the eurozone’s deeply stressed periphery, the country
became central to all efforts to address the crisis.
Germany’s consent was needed to create Europe’s “banking union,” which entailed the transfer of
supervisory powers to the European Central Bank and the creation of a common fund to resolve
failing banks. And German resistance contributed to a delay in the ECB’s intervention in bond
markets; when the ECB finally did launch its bond-buying program, it did so with Germany’s tacit
approval.
But now that interest rates are at zero, Germany’s large savings are no longer doing it much good.
And with the financial storm having largely abated, Germany lacks new opportunities to
demonstrate its political clout, both within and outside the eurozone.
Indeed, whereas Germany, owing to its deep involvement in Central and Eastern European
economies, was a key player in the Minsk agreements that were meant to end the conflict in
Ukraine, it has little influence in the Middle Eastern countries that are occupying the world’s
attention today. While many have highlighted Germany’s political leadership in the refugee crisis,
the reality is that being thrust into the front line of that crisis, without having much influence over
the factors that are driving it, is placing considerable strain on the country. Germany is now, for
the first time, in the position of having to ask its EU partners for solidarity, as it cannot absorb all
the newcomers alone.
As usual, however, perceptions are lagging behind reality, which means that Germany is still
widely viewed as the eurozone’s most powerful force. But, as the global business cycle accelerates
Germany’s return to the “old normal,” the power shift within Europe will become increasingly
difficult to ignore.
Germany, which exports a large volume of investment goods, benefited more than other eurozone
member countries from the investment boom in China and other emerging economies. But
emerging-economy growth is now slowing considerably, including in China, where demand is
shifting from investment toward consumption. This tends to undermine German growth and
benefit southern European countries, which export more consumer goods.
The ongoing shift in Europe’s economic and political power dynamics is likely to have a major
impact on the EU’s functioning – and especially that of the eurozone. For example, without a
strong Germany to enforce the eurozone’s fiscal strictures and urge the implementation of difficult
but necessary structural reforms, countries may lose their motivation to do what is needed to
ensure fairness and stability in the long term. If inflation remains low, the ECB might feel freer to
pursue further rounds of monetary stimulus, undermining fiscal objectives further.
In short, we may be headed toward a less “Germanic” economic policy in the eurozone. While that
might enhance the EU’s popularity in the periphery, it could increase resistance to EU membership
in Germany – a country that, despite its waning economic strength, remains an important piece of
the integration puzzle.