© REUTERS/Yves Herman

As often happens in disasters and wartime, leaders across Europe are riding high in the polls at the moment. Sociological studies have shown that in the initial moments of crisis, people tend to avoid negative thoughts about their governments because it makes them anxious.

As prime ministers and presidents bask in the glow of their high polling, they have been keen to run the show on their own. They have not let Brussels so much as lift a finger without their permission, nor have they coordinated with other leaders.

Uncoordinated Exits

This power dynamic is on display this week, as the European Commission adopts a pan-EU lockdown exit strategy on Wednesday. The strategy was supposed to be adopted last week, but at the last moment several EU member states including France, Spain, and Italy objected. They were concerned that any discussion of lockdown exits would be dangerous ahead of the Easter weekend when people would be tempted to go out, as they prepared to announce extensions. France, for one, will be in lockdown until May 11 at least.

These objections came despite the fact that the strategy, a draft of which governments had already seen, only contained guidelines rather than instructions for when national governments should end their lockdowns. The strategy will only communicate the European Centers for Disease Control’s advice for how restrictions should be gradually lifted and coordinated with neighbors. But that was too much for national capitals, even though they themselves had asked the Commission to draw up these guidelines on March 26.

In the ensuing week, national governments have pressured the Commission to water down the strategy so much as to make it essentially meaningless. The new draft shared with national governments on Tuesday changes the title from a roadmap toward “exiting” the lockdowns to one toward “lifting” the containment measures.

Scrubbed from the text are any mentions of an “exit.” Language saying governments “should” do things has been changed to “could.” The main recommendation is that any loosening of restrictions should be “gradual” and the general lockdowns should be replaced by targeted ones, for instance only for vulnerable groups.

Getting Restless

In the week’s delay, some national governments have become tired of waiting and have adopted their own national measures. Austria is starting its lockdown phase-out today, and Denmark and the Czech Republic have also announced their own exit plans. The Belgian government is expected to present its lockdown exit strategy tomorrow before the Commission unveils the EU strategy. National guidelines on mask-wearing have been contradictory, with Austria requiring it while other countries like Belgium are discouraging it.

What’s clear is that the Commission has lost the momentum on the exit strategy and has been preempted by national actions. Lockdown exits will probably be as uncoordinated, and perhaps also as chaotic, as their imposition. And this is far from the only area in which European countries look set to diverge.

Eurobond Divisions

Last week finance ministers from the eurozone countries—known as the Eurogroup—met for a grueling 16 hours of video conferencing over three days in a desperate attempt to overcome North-South divisions on what Europe’s economic response to the coronavirus crisis should look like. In the end, they were able to agree on making available a half trillion euros of funds available to firefight the economic fallout. But on the most contentious issue, joint guarantees on debt, they kicked the can to a summit of prime ministers and presidents on April 23.

The chief protagonists have emerged as the Netherlands on one side, representing the less-affected frugal countries of Northern Europe, and Italy on the other, representing the more-affected indebted countries of Southern Europe. They were able to reach a compromise on use of the European Stability Mechanism, an instrument set up after the 2008-12 financial crisis, which enabled both sides to declare victory. Though ESM funds normally come with conditions and oversight, that was seen as inappropriate in this crisis because the early heavily affected countries did nothing wrong. In the end they agreed on just one condition: the funds, up to 2 percent of national GDP, can only be spent on healthcare.

But on the debt issue, the Dutch as still giving a firm “nee.” Italy, France, Spain, and six other countries are asking for the eurozone to issue Coronabonds, rebranded Eurobonds. Germany’s response has been softer than its notorious resistance to Eurobonds a decade ago. The Netherlands has emerged as the most uncompromisingly staunch opponent, leading to vilification of the Dutch in Southern Europe over the past week.

Dutch Finance Minister Wopke Hoekstra says it would not be “reasonable” to “guarantee the debt of other countries.” For the Brussels press pack, it’s déjà vu. It would seem little has changed in terms of European solidarity, even in a new crisis where concerns about “moral hazard” and wasteful spending are not relevant. With little prospect of the Dutch relenting, some in the French government have floated the idea of doing regional joint bonds instead—perhaps a “Club Med Bond” for France, Italy, Spain, and Portugal.

Fraying Federations

It was only to be expected that the EU’s response to the initial panic phase of the crisis would be underwhelming. As a supranational confederation that has very few powers over health or borders, the EU isn’t built for circumstances like that. Where the EU has proven its worth in the past is in the response to crises, particularly in the economic response. But as the weeks go by, the shift to “more Europe” promised by European Council President Charles Michel is not materializing.

It is an issue being faced by federations across the world, from Russia to Brazil to the United States. On Monday two blocs of US states—a West Coast “Pact” and an East Coast “Council” —banded together to ignore the flailing federal government and form their own regional entities to coordinate lockdown exit measures. With California Governor Gavin Newsom still referring his response to that of a “nation state,” the implications of these regional decisions to ignore Washington could be profound.

It is clear that the coronavirus crisis is presenting an existential challenge to the European Union. But it is also presenting a challenge to the union of American states, one that could have long-lasting consequences. The outbreak may be global, but its effects are being felt in extremely varying ways locally, and it is not respecting national borders or federations. All governing structures are at risk.

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© REUTERS/Remo Casilli

It’s a question that is being asked increasingly frequently these days: Does the nationalist-populist Italian government really want to lead the country out of the eurozone? Is that what Matteo Salvini, who is drifting further and further to the right, wants? The head of the Lega was effectively already setting the tone of the government, in his role as interior minister and vice-premier, especially when it comes to migrants. Now, ever since his party won the European elections with 34 percent of the votes, he seems to have effectively slipped into the role of head of government, determining financial policy and relations with the EU as well.

Salvini likes to use “Brussels” as a scapegoat. On the one hand it’s migration—the EU wants to turn Italy into Europe’s home for asylum seekers, he warns his supporters; on the other it’s “austerity policy”—which he says has brought Italy to its knees. Political scientist Vittorio Emanuele Parsi believes that his arguments are not always without merit. “Because it’s true that the EU’s measures have turned crises that could probably have been overcome with other approaches into chronic weaknesses. Salvini, however, is only focusing the spotlight on one part of the problems. He completely ignores the fact that Italy has also contributed to this.”

“Italians First”

Salvini pulls out his motto “Prima gli italiani,” or “Italians first,” like a miracle weapon whenever the opportunity presents itself. That is particularly so now that the European Commission has recommended an excessive deficit procedure against Rome because the government did not abide by the agreements negotiated with Brussels in December 2018. Instead of falling, the national debt has risen further to 134 percent of GDP.

As expected, Salvini was unimpressed by this EU measure. “If the ones in the EU like to do so, they can go on sending letters,” he let Brussels know, arguing he would not let it dissuade him from his plan to introduce the promised flat tax—which would cost another €30 billion—because “it is not only our right, but our duty to reduce the tax burden.”

The suspicion that he might be up to something completely different, namely leaving the EU altogether, so-called Italexit, is not based solely on the harsh words spoken to Brussels, but on another initiative that comes from the Lega. Exactly two days after the European elections, on May 28, the Italian parliament approved a motion obliging the government to introduce “mini bots.”

The Bots Are Coming

The abbreviation “bot” stands for “Buono ordinario del Tesoro” and is a short-term debt instrument with which Italy finances itself, quite legally, on the internal and international markets. However, the situation is quite different with the mini bots already provided for in the coalition agreement. These are to be offered in small denominations, ranging from €5 to €500, have no expiry date, and primarily serve to repay the debts of public administrations to private companies. These amount to €57 billion. Companies would then be able to pay social and tax contributions. Many economists, however, see something else behind it, namely the first step toward a parallel currency.

And they may be right because the current Lega chairman of the budget committee, Claudio Borghi, declared exactly that in a 2017 video. The president of the European Central Bank, Mario Draghi, also seems to suspect plans for a parallel currency, which is why he spoke out against it at a press conference in Vilnius at the beginning of June. Either it is a payment instrument that is equivalent to money, which is forbidden in the monetary union, he said, or it is additional debt.

After the international sensation that the mini bots have caused, Premier Giuseppe Conte and Finance Minister Giovanni Tria, both of whom are independents and not members of either governing party, were eager to calm things down and assure people that these instruments would not be implemented. But where were they when the motion was tabled?

And the question that now arises is how far Salvini really wants to go. “Salvini will pull the brake at the last moment,” predicts economics professor Maurizio Ferrera who recalls an incident last November when a tranche of Italian government bonds remained almost entirely unsold. “There is talk of tens of billions of euros. Not even the Chinese had taken up the offer, even though they are among the most important buyers of our bonds. At that time Salvini was in a clinch with Brussels because of the Italian budget and the markets reacted nervously.” Ferrera believes it is quite possible that both the officials of the Italian National Bank and those of the government office persuaded him to act responsibly at the time.

Italy has to release government bonds on the market almost every month, and the more unstable the government is, and the wilder its economic and financial policy are, the more cautious the big investors become. And so, at the end of the year a deficit of 2.04 percent was agreed with the EU instead of the 2.4 percent initially demanded. The same could happen now. “Salvini must show consideration for his clientele,” Ferrera says. And a large part of them, at least in northern Italy, would not approve of a further increase in risk conditions and certainly not of Italy’s withdrawal from the euro. An opinion that Parsi also shares. “Salvini is a great opportunist,” he says. “He is only interested in one thing, the maintenance of power, not the principles.”

A Flash in the Pan?

But would an Italexit even work—for example, via a referendum, as in the United Kingdom? Parsi says no. “Our constitution prohibits them in the case of international agreements.” So, if Italy, in an extreme case, violated the treaties, it could only be thrown out of the eurozone. This is an option that had already been considered in the case of Greece, but then rejected, not least because German banks in particular would have suffered as a result. Ferrera also believes that while the other member states could bail out Greece that is not possible when it comes to Italy, which is also too big to fail. “But beside this, if there were a serious danger of being thrown out, our president, Sergio Mattarella, would intervene, address the nation, and bring the politicians back to their senses, I am sure of that.”

Since Italians know themselves since the economic crisis that they shouldn’t alienate the financial markets, the danger of an Italexit could prove to be a flash in the pan. It is doubtful, however, that there is going to be a more harmonious relationship between Rome and Brussels in the future, especially now that the new EU posts are due to be filled.

Today, three Italians hold top positions: Draghi, Antonio Tajani, the president of the European Parliament, and Federica Mogherini, High Representative of the EU’s Foreign and Security Policy. But that could change drastically now, and Italy risks having to settle for second-rank posts. If it were up to Salvini, he would like to see an Italian as the EU Commissioner for Economic and Monetary Affairs. But it is doubtful that this wish will come true.

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© REUTERS/Toby Melville

As Europe was preparing to introduce the euro in the 1990s, the American Nobel Prize winner for Economics, Milton Friedman, wrote a short essay in which he addressed the plans for a common currency. A common currency would not unite the continent as Europeans hoped, but rather divide it—for it would all of a sudden make processes of economic adjustment that “would have been easy to handle by changing exchange rates” difficult to manage.

In retrospect, it’s safe to say Friedman was right. The common currency was supposed to bring economic stability to the continent; it did the opposite. In the first ten years after its introduction, the euro brought an unhealthy boom to the south and a long-lasting slump to the north—above all to Germany. These tensions eventually exploded into a great crisis that nearly broke up the currency union. So it’s no surprise that there are warnings galore about the next crisis in Europe, even if the continent is not so badly positioned, in economic terms, as many make out.

The main problem of the European and every other currency union is that membership is an economic straightjacket. It limits the options available to a nation because the national currency can no longer be devalued in order to rebalance the economy. This is particularly difficult when economic imbalances emerge between the member states—when, for example, wages in one country increase too quickly compared to those in the others, making industry in the country no longer competitive.

The necessary corrections must then come in the form of wage reductions, which carry much greater political and social costs than a currency devaluation. On top of that, a member state in a currency union no longer has at its disposal a central bank that can, in a crisis, act as a creditor of last resort for the public sector. Therefore, economic difficulties, when paired with a capital flight of private investors, can quickly endanger the supply of liquidity. That’s exactly what happened during the eurocrisis and contributed significantly to its escalation.

Rules Are Not Enough

This structural shortcoming cannot be redressed by a national policy of reform, no matter how ambitious. It must therefore be offset on the supranational level, through instruments that reduce the costs of adjustment. That has happened, at least partially. First and foremost, there is the European Stability Mechanism (ESM) established in 2012. It offers, in exchange for reforms, emergency loans to countries in danger of losing their access to capital markets. That all seems very technical at first glance, but the ESM has in fact changed a central point of the eurozone architecture. The Treaty of Maastricht—the founding document of the common currency—conceived of the currency union as a system of rules: whoever didn’t follow them would have to live with the consequences, which in turn was meant to have a disciplinary effect on political decision-makers, so that they wouldn’t get into a situation where they needed to apply for outside help in the first place.

The founding of the ESM—and the Germans who filed a suit against it at the country’s highest court correctly recognized this—is an admission that trust in the power of rules as an organizing principle for the monetary integration of countries that are sovereign yet economically closely aligned is not enough. The European Central Bank (ECB) has also in essence followed this logic with its crisis policies. By buying bonds, the central bank can react to financial distortions in individual member states, stabilizing these countries. From the perspective of the affected countries, it is carrying out to some extent the function of the national central banks they lost with the introduction of the euro.

In comparison with other federal entities, the member state-centric structures of the eurozone certainly do no more than meet the minimum requirements. When there’s a crisis in the United States, for example, centralized unemployment insurance ensures that money effectively flows from less-affected to more-affected regions. Germany even possesses an instrument (the Länderfinanzausgleich) for aligning standards of living independently of cyclical fluctuations. The currency union won’t have anything like this in the foreseeable future because there is simply no political majority for the necessary transfer of sovereignty to the supranational level. And without such a centralization of political decision-making power, financially solid countries won’t agree to American- or German-style transfer mechanisms, because they fear they will have to pay for the economic policy missteps of other countries.

Reducing the Danger

But maybe the issue can be scaled down. At the moment, EU member states are discussing the introduction of a Europe-wide unemployment reinsurance and the expansion of the ESM into a European Monetary Fund with additional credit lines. An embyronic common budget for eurozone member states has already been agreed, despite resistance from northern European countries. Such reforms make the currency union less susceptible to crises—and they come with significantly lower legitimacy preconditions than would more extensive federalization on the US model. This also applies to the planned completion of the banking union, a step by which an important financial contagion channel would be closed. Countries like Ireland, for example, get into difficulties because the collapse of large national banks drags the whole economy into the abyss. A collaborative clean-up of the credit institutes—and having bank creditors bear a greater share of the associated costs—reduces this danger.

In this context, it should not go unmentioned that the eurozone doesn’t need to shy away from comparisons with the other big currency zones. The budget deficit in the eurozone amounted to one percent of GDP last year; in Japan it was 3.7 percent; in the US four percent. Public debt in the eurozone amounts to 86 percent of GDP; in the US it is 105 percent; and in Japan it is a whopping 229 percent. Nowadays the unemployment rate is sinking even in the countries of southern Europe, while in the north some regions enjoy almost full employment. And the economic differences between the prosperous regions in America’s coastal cities and the left-behind regions in the Midwest may well be—at least if socio-economic indicators like access to healthcare are included—bigger than those between Portugal and Germany.

Politics, Not Economics

The problem with the debate about crises in the currency union is that it generally operates with binary solutions. The assumption is that the eurozone can only survive if it is either built into a sort of European super-state, or if competences are comprehensively transferred back to the member states. In fact, it is entirely possible that it has a future as a hybrid entity that unifies governmental and regulatory elements, provided it finds the right balance between these two methods of political management. In any case, the US example shows that having the characteristics of a national state does not protect against economic irrationality.

Of course, that doesn’t mean that in Europe everything is in great shape. In countries such as Italy or Greece, the high level of public debt limits the fiscal room for maneuver, which is why the money for urgently needed investments isn’t there. There are still too many bad loans on the books of many southern European banks. If the ECB ends its ultra-loose monetary policy—as it will do sooner or later—then exactly these heavily indebted countries will suffer. And the budget plans of the populist Italian government, which went against European budget regulations, show how fragile the economy recovery is. For now, Rome seems to be backing down. But the recent worries are a salutary reminder of how an escalation of the crisis in Italy would affect the entire eurozone. Given the size and economic importance of the country, such a crisis could not be overcome with the existing instruments.

If the confrontation over Italy’s budget teaches us one thing, it is this: Europe’s real problem is not the economy but politics. After all, it’s not impossible to cut down excessive public debt if, as is the case in Italy, the population possesses considerable private wealth. Nor is it impossible to reconcile national priority-setting with European requirements as long as both sides are prepared to compromise.

You could also say it this way: there is no reason why the next great crisis has to originate in Europe. Unless it is willfully brought about.

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© REUTERS/ Remo Casilli

The dust has settled, and a coalition of the League and the 5 Star Movement is governing Italy. Many European commentators have greeted the new government with shock: They worry that Italy will put the eurozone at risk and act as a spoiler within the EU, blocking other countries’ attempts to reform the union and undermining European unity on Russia.

These fears are probably overblown. The friction between Rome and Brussels is likely to be manageable for the time being, in part because domestic politics and international financial markets will constrain Italy’s freedom of action.

But this is not a reason for the EU to be complacent. If the EU does not do more to convince Italians that they benefit from the EU, the chances of Rome becoming more confrontational, and of an Italian exit from the euro or the EU will increase in coming years. This would be a disastrous development for Brussels.

Why do other member-states have concerns about Italy’s new government? The first issue is the new government’s economic program. The coalition has promised a series of tax cuts and increases in social spending, which if implemented would increase the deficit to around seven percent of GDP, breaking a host of EU rules and forcing a showdown with the Commission. But it is very unlikely that the government will even try, let alone be able, to implement such a radical program. A fiscal expansion of such magnitude would panic financial markets, raising the yields on Italy’s debt and hitting Italian banks hard. If financial crisis loomed, Italy’s government would likely step back from the brink. It relies on a small majority in the upper house and could be replaced if MPs defect.

The Five Star and the League know this and have already staged a climb-down. It now appears that the planned tax cuts will unfold over time, while the promise of a universal basic income has turned into a promise of an enhanced unemployment benefit limited to two years. In reality, both may never happen. Instead of embarking on a collision course with the markets and the EU, Rome is much likelier to simply run a slightly higher deficit, in the order of 2.5 to 3 percent of GDP. This would violate the EU’s Fiscal Compact, which mandates small ‘structural’ deficits (deficits adjusted to economic cycles) and speedy debt reduction—allowing coalition leaders Matteo Salvini and Luigi di Maio to celebrate Italian liberation from the ‘diktats’ of Brussels. But it would not panic international bond markets.

In fact, the key problem presented by the new government in Rome is not its economic policy as such, but that it will make reform of the eurozone more difficult. For the 5 Star Movement and the League, stricter European oversight of national governments’ financial and fiscal policies is a non-starter. Yet such oversight is precisely what Germany and northern member-state demand in exchange for deeper risk-sharing in the EU. They will not trust this Italian government to carry out significant risk reduction in its banking system. As a result, any move towards banking union will be slowed down.

Aside from economic policy, analysts are concerned about the new government’s foreign policy, particularly its position towards Russia. The Five Star and especially the League are friendly towards Moscow. In his inaugural speech PM Giuseppe Conte called for a ‘revision’ of sanctions. Italy’s stance, combined with the relative rapprochement between the EU and Russia prompted by Donald Trump’s trade tariffs and withdrawal from the Iran deal, has raised the possibility that the EU could ease sanctions over the next year. However, Italy is unlikely to push for a removal of sanctions by itself. Doing so would drain political capital that Rome would rather use in the economic sphere, where it could be tempted to use the threat of vetoing sanctions as leverage. Instead of attempting to ease sanctions, it is far likelier that Italy will attempt a balancing act, seeking to maintain EU unity while also boosting political and trade ties with Moscow. Many Italian politicians, of all stripes, do not see this as a contradiction—and point to Nord Stream 2, the controversial pipeline that will bring Russian gas to Germany, as evidence that other member-states have long been practicing this.

This Italian government will also be friendlier towards the Trump administration than many in the EU. Rome will probably seek to use its foreign policy influence to prevent or limit escalation in the transatlantic trade war. At the G7 meeting last week, the Italian PM expressed his skepticism about escalating the ongoing dispute with Trump. Italy is not the only member-state to doubt the wisdom of escalating the spat with the US: Germany has also taken on a softer stance than France. And other states, such as Poland and the Baltics, have sought to maintain good relations with Trump because of their reliance on the US for deterring Russia. They, too, are likely to shy away from further escalation, giving Italy some allies.

In essence, Italy is unlikely to act as a spoiler. While Rome will argue with Brussels and work to soften Europe’s stance towards Russia and the Trump tariffs, it almost certainly will not pursue radical economic policies incompatible with euro membership or seek to remove all sanctions on Russia.

The EU’s job: Compromise with the Italians

But in the medium-term, things could get worse. Brussels should not be complacent about Italy. Italians feel the EU has abandoned them in the eurozone crisis and the migration crisis. They have become much more critical of the EU than they were prior to 2008: The latest Eurobarometer survey shows only 44 percent think EU membership has benefited Italy.

The EU should try to work with the government in Rome. It should allow Rome to slightly raise spending—especially if this comes in the form of investment—and thereby secure a symbolic victory over Brussels. As things stand, it appears that the EU will open ‘an excessive deficit procedure’ in response to increased Italian deficits. The procedure would monitor the Italian budget and suggest corrections to Italian finances. The political impact of this familiar move could be contained: Spain is still in the procedure, while France was in the procedure from 2009-2018 and escaped Commission fines. But if the EU ends up issuing Italy a fine, it will merely reinforce the idea that the EU dictates Italian policy, and encourage the Five Star and the League to lash out and espouse more uncompromising positions. A small fiscal expansion may even have the effect of boosting growth and lowering the overall debt/GDP ratio.

The EU should also step up its efforts to help Italy manage migration flows. So far, the EU has focused its efforts on reforming the Dublin regulation, which stipulates that the first member-state an asylum-seeker enters is generally responsible for determining that person’s asylum status. But reform has stalled. It is difficult to imagine that member-states will be able to agree on a relocation scheme of a sufficient magnitude to take the pressure off frontline countries. Additionally, the Dublin-centric approach does little to address factors that push people to migrate, and the difficulties that member-states have in returning rejected asylum-seekers to their countries of origin. A better way for the EU to show solidarity with Italy would be to put money on the table to persuade African countries to sign agreements to take back their citizens. It should make available funds of the same order of magnitude as the €6 billion already pledged to Turkey.

If the EU does not do more to convince Italians that the EU benefits them, Italians are likely to become even more euroskeptic – to the extent that leaving the euro would no longer appear unthinkable. If Italy defaulted and left the euro, the ensuing financial crisis could lead to the unravelling of the euro, and fracture the EU.

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© REUTERS/Kevin Lamarque

Fear of Donald Trump is a powerful force. The US president’s erratic and vindictive style of foreign policy has, for example, brought the presidents of North and South Korea to the negotiating table out of sheer fear of a possible US military intervention.

More recently and on the other side of the world, fear of Trump is having an impact on Germany’s chancellor Angela Merkel. After many months of delays, she finally set out her position on EU reform. In an interview with the Sunday paper Frankfurter Allgemeine Sonntagszeitung (FAS) [paywall], the German chancellor explained her ideas on reforming the eurozone and creating a common European asylum and defense policy.

Merkel’s approach is just as sober and cautious as one might expect, but at least it’s there, and in time to cobble together a Franco-German proposal for the next EU summit at the end of June. The French President Emmanuel Macron, who recently celebrated a very public friendship with Trump, must be sighing with relief.

Finalement, une Réponse

Of course, it’s not all about Trump. Merkel was already under pressure to come up with a proper answer to Macron, who has spent a lot of political capital on EU reform. Germans like Macron and his visionary courage, and they don’t want their chancellor to let him down.

But arguably, it is Trump who has driven home the most important lesson for Merkel: with him in the White House, she needs Europe even more than Europe needs her. Of all the leaders in the world, it is Merkel that Trump has taken a particular dislike to: because she worked closely with his predecessor Barack Obama; because she refuses to flatter him; because after his election she was hailed as the new leader of the liberal West; because German exporters are so successful; because Germany doesn’t spend enough on American armaments; and, probably not least, because she is a woman.

Trump received Macron with great pomp in Washington in April; Merkel, visiting two days later, was scheduled in as a simple working appointment. Under other circumstances, Merkel might have been happy enough to escape a black-tie dinner at the White House, but the snub must have hurt.

Much more painful, however, are the policy issues. Trump’s unwillingness to clearly confirm NATO’s mutual defense agreement leaves Germany feeling more unsecure than in many years. At the same time, the American president is contributing to the destabilization of the world – moving the US embassy in Israel from Tel Aviv to Jerusalem is one example, tearing up the nuclear agreement with Iran another.

In dealing with Germany, the US administration is not limiting itself to foreign and security policy. Trump’s brash new ambassador to Berlin, Richard Grenell, made headlines by announcing that he wants to “empower” anti-establishment conservative movements across the European continent and criticizing the “failed policies of the left”—a sharp break with diplomatic tradition, as ambassadors usually stay out of the party politics of allied states. Grenell was asked by the German government to explain his remarks.

But Trump’s sharpest tool for getting at rival countries like Germany is trade policy–first with additional import tariffs on steel and aluminium, and now with the threat of levying an extra 25 percent on auto imports. No industry is as central to the wellbeing of Germany’s economy as the automobile industry; this comes close to a declaration of economic war.

On trade, Germany clearly needs Europe to remain united – and it is doing so, so far. EU Commissioner Cecilia Malmström has the backing of all EU countries for lodging a complaint with the World Trade Organisation and imposing retaliatory tariffs against Washington. But Trump has a sharp instinct for the fault lines. Bilateral deals have already become a huge temptation. Just take the example of Warsaw, which reportedly offered to pay the US up to $2 billion for permanently stationing a heavy division in Poland. Such deals could spell the end of NATO.

„In today’s uncertain times, Europe must be able to act at any time,“ Merkel said in her interview with FAS to explain why she was joining the drive to reform the European Union.

Cautious Steps Forward

On defense and asylum, her proposals for a common European intervention force and a joint European migration agency will go far to satisfy Macron, even though it will be difficult to get the rest of the EU on board. On the thorniest issue of all, eurozone reform, Merkel’s cautious offerings on setting up a European Monetary fund and creating joint funds for investment and short-term debt relief are certain to disappoint Macron.

Here, of course, Merkel’s own conservative bloc is very hesitant. The huge spending plans of the new Italian government have not encouraged Berlin to become more generous. Yet Merkel also knows that in its current shape, the eurozone may not be able to withstand another crisis.

France and Germany have just three weeks to flesh out a substantive common proposal on the eurozone before the EU summit. Will it be enough? For his part, Macron seems to think the glass is half-full. “These are steps forward,” one French government official told Reuters. He then added: “There is still a lot of work to do to get an ambitious agreement on the European economic union.”

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© REUTERS/Leonhard Foeger

How would you put the FAZ letter signed by 154 German economists into context? What does this letter signify? We have three camps in Germany by now when it comes to Europe. We have those who have a very anti-European ordoliberal, neoliberal view. You have a second camp with politically left-wing, very Keynesian, occasionally extreme views demanding a true European republic. And then you have those who are more pragmatic and less dogmatic (I would put myself in that camp).
The call by the 154 economists is a very strong euroskeptic message that basically rejects any progress on integration—and even worse, I believe, it is actually calling for an unwinding of some integration measures, for example by making it possible to exit the euro. But if you do that you’re creating something that’s akin to a fixed exchange rate system where members can leave at a whim. If that happens, markets will react and speculate against this or that country.
I’m concerned about the letter, not only because I feel the proposals are wrong-headed, but also because of the crisis it can lead to. Take Italy, where the political situation is extremely uncertain and euroskepticism is gaining ground. To demand, in such a situation, that we should be tough on Italy and force them from one day to the next to reduce debt and repay loans is to run an incredibly high risk of triggering a crisis. That’s not good economic policy; rather, it exemplifies a nationalist view on Europe that’s potentially damaging.

How influential are these economists? They are a minority even in the ordoliberal camp that had its heyday perhaps 20 years ago. And if you look at the demographics of this group it’s male-dominated, older, with a traditional outlook that lacks a European perspective. The right-wing populist Alternative für Deuschland (AfD) immediately said, “Finally a group that’s confirming and supporting what we’ve been saying”’ I don’t really want to comment on that, but it does say a lot. In short, this group is certainly not representative of German economists. It’s not even representative of German euroskeptics.

The letter warns again a “Haftungsunion” (liability union) and a “Transferunion” (transfer union), the latter implying that Germany is paying too much for Europe. Isn’t that a widely-held perception? First, Germans are very pro-European, young Germans in particular. You see that in every survey. And Germans on average understand the need for more integration, more so than people in central and eastern Europe or southern Europe. That’s an encouraging signal. Second, some people are stoking fear by saying, “All the other Europeans want is our German money.” Haftungsunion is a manipulation aimed at scaring people. It’s triggering the sentiment that we are the paymaster of Europe, that everyone else is misbehaving and all they is our money. And that’s just not the case.
If you look at the last ten years, what has Germany actually paid for? Germany has given loans. The ESM (European Stability Mechanism) has lent money to Greece, to the Greek government. What has Greece done with that money? To a large extent they have repaid their credits with German and French banks; in other words, they have protected German taxpayers. You can now complain that German banks shouldn’t have been bailed out—and I would agree with that completely—but it’s not correct to say German taxpayer money has been transferred to Greek taxpayers who are lazing on the beach, living off German money. That’s the impression a lot of people get when they read these texts but it’s simply wrong.
The third point I wanted to make is on the Haftungsunion, which one perhaps can translate as liability or insurance union. It’s about sharing risks; that’s the whole idea of Europe, the whole intention of integration. Everyone benefits from an insurance union. Take health insurance. Of course people who are healthy, who live well, who exercise regularly, eat well, and are lucky enough to be less exposed to genetic illnesses will contribute more than they will receive in benefits. Others who may have bad luck because of an accident, or because they are more exposed to specific risks, will get more money out than they pay in. So should we not have health insurance because some people benefit more than others? Of course not. Everyone benefits from it. Even if I’m the healthy one, I’m happy to pay more money knowing that I will be taken care of if I fall ill. That’s also the whole idea of Europe: risk- sharing means all of us are better off, so Haftungsunion is not a bad thing. It’s actually what Europe is about.

Yet in the run-up to the next European summit in June, this seems to be the only issue making a big splash; there’s no other real debate in Germany. Do you share that impression?  We need to have more of a debate, I agree. In January, I was one of 14 French and German economists co-writing a paper about which European and monetary union reforms are needed to balance interests and make progress. And to be honest, if the FAZ letter is the best the euroskeptics and the nationalists can come up with, then I’m not worried. If that’s the best shot they have, I think we’ll be in good shape in Germany to do the right thing, namely to have a sensible reform of monetary union.

Does that mean that you’re quite optimistic for the upcoming European summit in June? I don’t think the June summit will see a breakthrough. I think it’ll be a starting point for the French and German governments to get together and to work over the next half year to really put in place sensible reforms of monetary union, and of the EU as a whole. There is a sense of urgency if you look at Italy or at Brexit. There’s a window of opportunity now, before the European elections next spring. It’s the right time to do it. Europe is doing well economically, so now really is the time.
That’s why I’m not too optimistic for the June summit, by the way: the economy is doing too well. People don’t understand why we should undertake tough reforms now, at a time when Europe is recovering. And my answer is precisely because we’re living in relatively good times. You fix the roof when the sun is shining; you don’t repair it once it starts raining. Then it’s too late and the damage is done. But I hope and think that the German and French governments are well aware of that and that they will have made progress by the end of this year.

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It might be one of Chancellor Angela Merkel’s greatest challenges yet. After nearly two months of wrangling, her conservatives still have not yet managed to form a coalition government with the Greens and Free Democrats. It is a tricky marriage indeed: the three parties remain miles apart on fundamental issues like climate policy, immigration, and eurozone reforms.

Yet Berlin can hardly afford to waste any more time. Governments across Europe are looking to Germany to take charge on a host of pressing internal and foreign policy issues, but also to lead the push to reshape the EU itself. One man in particular is watching closely to see what emerges from Berlin’s contentious coalition talks. Just two days after the German elections, French President Emmanuel Macron delivered a sweeping speech at the Sorbonne where he fundamentally raised the stakes in the EU reform debate.

In an almost one-hundred-minute long speech, Macron laid out a comprehensive and ambitious vision for a new Europe, underlined by a strong emphasis on institutional innovation. In the field of security and defense for example, Macron pitched for a common intervention force, which – at least in principle – is a more ambitious version of the already existing but never used EU battle groups. On domestic security, he called for boosting the responsibilities of the newly established European Public Prosecutor’s Office and for establishing a European Intelligence Academy that would foster closer cooperation among member states’ intelligence services. On migration and asylum, he repeated the Commission’s proposal to create a European Asylum Office and suggested the gradual establishment of a European border police force.

No Revolution

The timing and vast scope of Macron’s speech garnered much attention: His drive and ambition come at a time when the EU seems to be looking more optimistically to the future. But his proposals are far from revolutionary; in fact, most of them have been on the table for a long time. However, Macron’s European drive and ambition have given those ideas new visibility – rearranged, bundled, and well-timed at a moment when the EU seems to be looking more optimistically into the future.

Despite being concrete and assertive about most of his proposals, Macron was careful not to draw red lines for the French position to avoid overpromising with his reform agenda or overburdening his European partners with too much too soon. Indeed, he depicted his vision for change as a plan that needs further debate, leaving enough room for maneuver in future negotiations.

On the most contentious issue – the strengthening of the eurozone – Macron climbed down from his initial, ambitious plan. Keenly aware that the coalition-building process in Germany could be complex and protracted, Macron constrained himself to attributing only a small part of his speech to eurozone governance. He repeated the need for a sizeable common eurozone budget but avoided any concrete figures, and suggested a particularly generous timetable for implementation that would allow eurozone members critical of his proposals ample time to work through their disagreements.

This strategy could help avoid conflict with a future German government. Macron recognizes the importance of Paris and Berlin jointly leading the EU reform agenda, and Berlin’s endorsement of his overall approach to reforming the European project in the long run is more significant to him than his eurozone reform plans in the short term. Indeed, Macron consulted Chancellor Merkel twice in the process of drafting his speech.

Discouraging Signals

But will it help? The French president has already been forced to postpone his initial plan. Now, as German coalition talks have ground to a halt, Macron is condemned to wait for a German response, and the signals he has received along the way have not been particularly encouraging. While Chancellor Merkel welcomed Macron’s proposals as a “good impetus” and the Greens’ leader Cem Özdemir urged taking “Macron’s outstretched hand,” the liberal FDP and the more conservative wing of Merkel’s CDU/CSU have been lukewarm at best. There is strong resistance to any kind of common eurozone budget, a banking union, or the establishment of a European Monetary Fund. That does not leave much scope for changing the status quo on eurozone politics.

Still, there is overlap on defense and security, corporate tax alignment, and a common asylum policy. An agreement in these fields could be packaged together with more contentious issues to at least push things forward. This, however, would presuppose the formation of a stable government and a coalition agreement vague enough to leave space for negotiations between Paris and Berlin – a lengthy and tedious process in itself.

Even if a German response comes soon and Paris and Berlin are able to get their rusty tandem back on the road by developing a series of reform measures, discontent may grow among other member states and hamper urgently needed consensus on reform. Thus, openness to other European heavyweights eager to shape the EU reform agenda, particularly Italy and Spain, will be key.

Advancing or Preserving?

The largest stumbling block will be the idea of deeper integration, or moving toward a more political union in general. Macron champions the concept of differentiated integration, a “multispeed EU” in which a small group of member states moves ahead on issues where closer cooperation triggers a strong backlash. But Warsaw, Budapest, and Prague, in particular, are not interested in cementing their positions outside the inner circle of EU decision-making – especially as the position on the margins has been weakened considerably with the British vote to leave the EU. At the same time, the appetite to deepen EU integration among member states like the Netherlands or Austria might also be waning after recent election results.

Against this backdrop, and with Brexit negotiations sputtering, it is no wonder that European Commission President Jean-Claude Juncker’s overriding concern is preserving the unity of the EU’s remaining 27 member states. Chancellor Merkel, too, has made it a priority to prevent the rift between core and periphery from deepening further. That only leaves room for functional and pragmatic forms of differentiated integration, like the flexible cooperation we have seen in security and defense.

President Macron has tried to push the EU reform debate squarely into the spotlight and spur his European partners to act; by making EU reform the central project of his presidency, he is taking a significant political risk at home. His proposals are concrete and serious, yet the response across the bloc has been largely skeptical. It is not surprising to see criticism from Central European countries, but Macron may well have been hoping for a warmer reception in Berlin.

Yet Germany, mired in intricate coalition negotiations, might be too paralyzed to act at a time when a rare window of opportunity to reform the European project seems to have opened. Nevertheless, in Macron’s rich menu of proposals it is at least likely that EU partners will find some aspects to pick up, even if the drive to reform is off to a slow start.

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© REUTERS/Michael Urban

In his final years Helmut Kohl often publicly complained about his estranged political protégée, Angela Merkel, without ever mentioning her name.

As the euro crisis raged in September 2011, he told this journal’s sister publication Internationale Politik he viewed it as unforgivable that doubts existed about German solidarity with Greece, a struggling fellow EU and eurozone member. “The enormous changes in the world are no excuse for having no position or idea where one belongs and where one wants to go,” said Kohl. “The enormous changes cry out for firm and clear orientation, for constancy and dependability.”

Since then, apparently heeding Kohl’s criticisms, Angela Merkel has performed several European policy pirouettes. For instance in the summer of 2012, amid renewed speculation over an uncontrolled Greek departure from the currency union, the chancellor returned from her holiday having decided not to let Greece default on its debts and crash out of the eurozone. Then, that autumn, she told the European Parliament that she favored further European integration. “Nothing else,” she said, “will work over the long term.”

Reconciliation of Sorts

These tentative shifts, on Greece and Europe, set the stage for a reconciliation of sorts with Kohl in September 2012, at an event she organized to mark the 30th anniversary of his election as chancellor in 1982. The occasion offered Kohl a plattform alongside Merkel to proclaim: “Long live Europe!” A short time later she had her press office circulate a photo showing the chancellor and her political mentor sitting harmoniously on the terrace of Kohl’s bungalow.

The next lap came in 2015 with a paradoxical role-reversal, this time involving Merkel’s Finance Minister Wolfgang Schäuble. Despite his own differences with Kohl, Schäuble sees himself as the executor of the former chancellor’s European legacy. And yet he was the one who put stirred the pot by pushing for the Greeks’ departure from the currency union. Schäuble was wary of the anti-European antics of the new leftist government in Athens and hoped waving the Grexit stick would bring remaining members into line, backing the kind of closer euro union Merkel didn’t want in the first stage of the crisis.

In the end, however, the strategy was too risky for the pragmatists in the chancellery: Merkel didn’t want to go down in history as the woman who destroyed Kohl’s achievement of currency union. By 2015 growing geostrategic pressures on Europe’s fringes made it unwise to tip the eastern Mediterranean into complete chaos. Soon Merkel’s mind was no longer on the euro but rather on the growing refugee crisis, which in early 2015 she dubbed “the greatest challenge that I have seen for the European Union in my term of office.”

She recognized that Germany could no longer use the EU’s Dublin refugee rules to fob off the asylum question to particularly burdened member states like Italy or Greece. In addressing the EU’s refugee shortcomings the European Commission – long viewed suspiciously by Merkel – became an ally. After taking a tough line in the Greek crisis, the chancellor didn’t want to be viewed as the leader who allowed refugees to rot at the EU’s borders, or who sacrificed the passport-free Schengen area on the altar of absolute German power.

But not even that vast humanitarian crisis could transform Merkel from a “sober European” (Vernunfteuropäer) into a “heartfelt European” (Gefühlseuropäer) like Kohl. She believes in EU economic reform because, after watching her East German homeland collapse, she is convinced that the only good Europe is a competitive Europe.

Because her points of reference were always West Germany and the United States, however, she struggled for a long time to grasp – and accommodate – the fundamental importance of France for German EU policy.

Salvage Operation

From the start, her European experience has been a salvage operation: tacking back together the pieces of predecessors’ grand visions that shattered when put into political practice. The EU’s recent existential crises, for instance, exposed the weaknesses of the currency and Schengen unions: two visionary ideas of Helmut Kohl that lacked crucial components in their foundations.

After managing several existential crises, important laps on Merkel’s European journey, the moment when Merkel gave up her fundamental opposition to further EU integration can be traced back to June 23, 2016, when the UK voted to leave the EU. The outcome was something no one in the chancellery seriously anticipated – and it changed everything.

Merkel’s post-Brexit priority: to hold the rest of the union together, at any price. That determination chimed with public opinion. Weeks after the British vote, Germany’s Allensbach polling institute found that Germans had become “more conscious of the European Union’s benefits.” For the first time since the fall of the Berlin Wall in 1989, a relative majority of Germans wanted faster European integration.

The chancellor felt vindicated by pro-European demonstrations under the “Pulse of Europe” banner and launched a round of shuttle diplomacy, visiting all the important and many less important European capitals before the post-Brexit Bratislava summit. By the time of their first gathering after the British vote to leave, the remaining EU leaders were more unified than ever.

The election of Donald Trump as US president was another key moment for Merkel. In a remarkable statement after his election the German leader – a passionate Atlanticist – spelled out a list of western values and added, “On the basis of these values, I offer Donald Trump close cooperation.”

All of a sudden, the community of Europeans had what it had lacked since the end of the Cold War: a common external enemy. And after the Brexit shock and Trump debacle, election results in 2017 have turned out far milder than feared: Dutch voters halted their populists, and the pro-European Emmanuel Macron secured a two-thirds majority for himself and a comfortable parliamentary majority. In Italy, where an election is due next year at the latest, poll numbers for the populist, euroskeptic Five Star Movement are in decline.

After Trump’s sobering visit to European institutions in Brussels and the G7 summit disaster in Sicily, Merkel did something she had criticized her predecessor Gerhard Schröder for a decade and a half earlier: she played the foreign policy card at an election event, this time in a Bavarian beer tent. “The era when we could depend entirely on each other is, in part, over,” she said, before adding a line dropped from the headlines: “We Europeans really have to take our destiny into our own hands.”

Merkel’s Plan

For Merkel the greatest priority in securing the EU’s future is addressing uncontrolled Mediterranean immigration. Another is greater German military cooperation with its EU partners: France, the Netherlands, Poland, and, more recently, the Czech Republic and Romania. A third component is reform of the European economic and currency union.  While Merkel has ruled out pooling member states’ sovereign debt – so-called eurobonds – she has never ruled out sovereign bonds issued by a future eurozone finance minister to support pan-European investment or as bridging loans for reforming governments.

There’s talk of a special tax to finance a eurozone budget and, for the first time since coming to office, Merkel used Macron’s inaugural visit to Berlin to flag readiness to change European treaties “if that is needed to strengthen the eurozone.”

Helping the new French president to succeed, where possible, is another component of Merkel’s European plan. Phase one involved lots of friendly words before the French parliamentary elections in June. The next phase begins after Germany’s federal election at the end of September. With that in mind Merkel will, in the looming election campaign, rule out nothing that could tie her hands afterwards. Quite the opposite: she is deploying pro-EU rhetoric to secure a mandate for further integration steps.

All of this is quite a shift for the German leader. Her decades of engagement in EU policy shows that concrete circumstances will dictate just how much of her plan becomes reality. She may have reconciled herself with the late Helmut Kohl and his European politics, but Angela Merkel will always remain a power pragmatist.

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© REUTERS/Alessandro Bianchi

Italy is in crisis. For a country that has seen more than 40 governments since the end of World War II, that may be not an entirely unusual state of affairs. But ever since Prime Minister Matteo Renzi’s big gamble failed when he lost a referendum on constitutional reform on December 4 with a 40-60 margin and resigned, questions about the eurozone’s third largest, if sluggish, economy and its brewing banking sector crisis have returned with a vengeance. The “no” vote has also created a vacuum within yet another influential EU member states. With upcoming elections in the Netherlands, France, and Germany, the EU already had limited capacity to act in 2017 – now Italy has added itself to the list.

Italian President Sergio Mattarella acted swiftly. He entrusted Renzi’s foreign minister Paolo Gentiloni with forming a caretaker government, which will use the existing center-left coalition in the parliament and lead the country until the next elections – at the latest in February 2018, but very likely sooner. The populist Five Star Movement and the right-wing Lega Nord (Northern League) have already called for snap elections – the former hoping to take advantage of Renzi’s crushing defeat and Italians’ general anger with the political class, as the party is polling head-to-head with Renzi’s Democratic Party. The latter also seems to favor a quick return to the ballot box. As a “political animal,” Renzi has not yet lost his appetite for the game: he we will quickly push for a new political mandate.

Still, Italy’s fellow eurozone member states seem to have undervalued the risks political uncertainty poses for the stability of the common currency. Frequent calls to reform the eurozone’s structure have been followed by little in the way in action; thus, the euro remains vulnerable to turbulence in the financial markets. It is true that the markets seemed to have expected a “no” in the constitutional referendum and have shrugged of the vote for the most part; however, a faltering economy, the second highest public debt ratio in the EU (at 133 percent of GDP), and the troubled banking sector point to big danger ahead, irrespective of who wins the next elections.

Key Problem: Italy’s Banks

The Italian banks constitute a key problem, as their bad loans amount to circa €360 billion in total. Italy’s third largest bank, Monte dei Paschi di Siena, is the biggest worry. Last summer the bank failed in a Europe-wide stress test undertaken by the European Central Bank, and is now obliged to address its capital gap. By the end of the year, the bank is required to increase its capital by raising up to €5 billion. After the referendum, the bank submitted a request for more time, which the ECB rejected – signaling that the financial environment is deteriorating. If this process fails due to political uncertainty, there is a risk the bank could collapse, which would undermine confidence in other Italian and European banks. The interim government would be forced to either step in and bail out Monte dei Paschi, which would mean involving the 60,000 bank savers in restructuring its costs, or asking the eurozone for help. The winner would be the Five Star Movement and other populist, anti-EU forces – either because of the loss of the savings of thousands of Italians, or because of the strict conditionality that would accompany a European rescue package.

An Italian banking crisis would confront the EU with a two-fold problem: First, a controversial theme would be back on the agenda. In the Dutch, French, and German elections, it would be difficult to convince these electorates of the necessity of saving Italian banks. Second, it is far from certain that the eurozone could maintain strict conditionality in the case of a member state as central as Italy.

Meanwhile, the debate on the legitimacy of the Italian electoral law, the so-called Italicum, is a decisive factor determining when the next elections will be held. At the moment, Italy has no single electoral law governing both chambers; the one in place was designed assuming a “yes” in the referendum and thus only applies to the lower house of parliament. The ruling by the constitutional court is pending and not expected before early 2017, but it will likely reject the current law, in which case the Gentiloni government will have to sketch out a new electoral law first and win parliamentary allies to get it passed – probably Forza Italia, the center-right party of former Prime Minister Silvio Berlusconi. It will likely result in a more proportional representation system (until the proposed reforms, the system gave bigger parties an edge). This would then likely reduce the chances that the Five Star Movement, which openly flirts with a referendum on euro membership, would come to power.

But as the heated atmosphere during the referendum campaign has shown, arriving at this point will prove tricky – and possibly unreachable should Italy’s banks go under while Italy’s policy-makers quibble.

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