Germany’s Dilemma Over EU Fiscal Rules

By Lili Bayer 

July 29, 2016

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Berlin is trying to enforce the bloc’s rules while also maintaining cohesion between its members. 

German newspaper Handelsblatt ran the following headline on July 28: “Deficit Delinquency: Schäuble Lets Spain, Portugal Off the Hook.” A day earlier, the European Commission formally recommended that Spain and Portugal not be fined for violating European Union deficit rules. Last year, Spain and Portugal’s budget deficits reached 5.1 percent and 4.4 percent of GDP, respectively. EU rules, however, mandate that countries bring their deficits down to below 3 percent of GDP. Countries in violation of these rules face fines of up to 0.2 percent of GDP – a hefty price for countries already struggling with double-digit unemployment and sluggish growth.

This short headline highlights both the power dynamics in Europe andGermany’s deep political dilemma. The reference to German Finance Minister Wolfgang Schäuble reveals Berlin’s continued central role in shaping key EU-level decisions. The formal recommendation not to levy fines on Spain and Portugal came from the European Commission, which was originally divided on the matter. Some members, like Commissioner for Economic Affairs Pierre Moscovici (from France), opposed fines. But others – including European Commission President Jean-Claude Juncker, Vice President for the Euro and Social Dialogue Valdis Dombrovskis (from Latvia) and Vice President for Jobs, Growth and Investment Jyrki Katainen (from Finland) – advocated that at least a symbolic fine be levied. Nevertheless, in the hours before the commissioners’ meeting, some commissioners’ phones reportedly began ringing. The caller was Schäuble, urging the commissioners to change their minds. And faced with this pressure from Berlin, they did.

Besides demonstrating Germany’s decisive influence on the outcome of the commissioners’ meeting, this headline also highlights that Germany sees countries like Spain and Portugal as delinquents. Delinquency implies both failure and guilt. Eight years after the outbreak of the global financial crisis and six years after Greece’s first bailout, the eurozone’s crisis is far from over. In Spain, European Commission data shows unemployment still stands at 20 percent. Moreover, gross public debt stands at 100 percent of GDP in Spain, 126 percent of GDP in Portugal and nearly 133 percent of GDP in Italy. At the same time, non-performing loans make up around 18.1 percent of all debt in Italy (360 billion euros or $403 billion), 12 percent in Portugal (33.7 billion euros) and 10 percent in Spain (129.2 billion euros).

But the core of Germany’s dilemma comes down to this question: if Germany sees southern European economies as delinquent, why is Schäuble making urgent calls behind the scenes to ensure that Spain and Portugal are not penalized for their delinquency? There are three factors that shaped Berlin’s decision.

First, Germany fears that fining Spain and Portugal would strengthen anti-establishment and anti-eurozone forces across the bloc. Spain and Portugal are fragile economies and the EU has already demanded that austerity measures be implemented in both. Furthermore, France, a political heavyweight, and Italy, a major economy, have received leeway from the EU when addressing their own large deficits. Imposing fines on Spain and Portugal could be seen among much of the public as battering economies that have already suffered greatly over the past several years, while also unfairly targeting smaller, less influential EU members – a perception that has already gained some traction in countries like Greece. As anti-EU sentiments grow across the Continent, Germany is becoming more attuned to public perception of the union – and particularly attitudes toward the eurozone.

The second factor is that Germany is increasingly feeling the effects ofsouthern Europe's economic troubles – and of the weaknesses of its own economy. In Italy, policy-makers are racing to raise more funds from banks and pension funds in order to circumvent EU bail-in rules and indirectly assist banks that are being crushed by the weight of non-performing loans. Meanwhile, in Germany, Deutsche Bank announced earlier this week that its net income fell by 98 percent in the second quarter, while revenues declined 20 percent compared to the same period last year. We have written extensively about Deutsche Bank’s troubles and the dire consequences for the German and European economic systems should the troubles of Germany’s lenders persist. Faced with these major developing crises, decision-makers in Berlin are thus opting to avoid risking additional economic disruptions in southern Europe, even at the cost of forgiving Spain and Portugal’s disregard for the EU fiscal rules Germany values.

There is a third, largely unspoken, consideration. The EU is fragmenting and some European leaders are increasingly opting to ignore or circumvent European rules. In this environment, Berlin could not be sure that if fines were imposed on Spain and Portugal, the governments in Lisbon and Madrid would respect the EU’s decision and pay the fines. Non-compliance would put the EU in a difficult position. From Berlin’s perspective, therefore, opting not to impose fines and negotiating future fiscal adjustments with the Spanish and Portuguese governments was a better strategic move than risking a public showdown that would further undermine the credibility of EU institutions.

Germany is grappling with a difficult dilemma. Berlin has generally pushed for strict enforcement of EU rules, especially when it comes to spending. And yet, as the EU weakens, anti-EU movements grow in strength and Europe faces significant economic risks emanating from banks, Berlin is adjusting its approach. For some, it may appear that Germany is letting Spain and Portugal off the hook, but in reality this is part of a desperate attempt to protect Berlin’s interests. Germany is making exceptions to EU rules in an attempt to keep the bloc from fragmenting, but more exemptions may ultimately erode the EU's coherence even further.