Last week the German government’s economic forecasts for 2013 have made clear that the Euro crisis will have a serious economic impact on Germany, with the economic growth projection cut down to a mere 0.4 %.
The main reason behind this cut is the lower than expected increase in exports – the main driving force behind Germany’s excellent economic performance in the past years. With a now somewhat lower economic growth in China, the recessions in many Eurozone crisis countries will finally be felt in Germany.
To be sure, authorities see only a short interruption of the remarkable economic recovery of Germany after the 2008-2009 crisis and project that economic recovery will be just around the corner.
But what if Germany as the last important well-performing Eurozone country would really go into a recession?
When Germany is not the engine of economic development and growth anymore, with France and other Eurozone core countries already in even greater problems, the Eurozone crisis would enter into a new phase by losing its core centre of stability. What can we expect in 2013 if this happens?
To start with, lost confidence in Germany and its ability and willingness to provide finance to keep the sovereign debt and banking problems under control could easily lead to a new vicious circle with increasing dangers for financial stability, given the still undercapitalised European banking system.
The achievements of the past year that have helped stabilise the Eurozone, such as the introduction of the European Stability Mechanism (ESM), the proposed Banking Union and the new fiscal compact – how limited they may ever be – can be put in jeopardy. This could result into an intensified crisis which would – according to the current crisis management script – require even more painful austerity in the problem countries and more financial support from core countries like Germany while the latter being themselves in trouble. As a consequence, the electorates on both sides may not be willing to bring even more what they consider as “sacrifices” for the single currency.
All this sounds frightening. But is it a plausible scenario?
May be not, because this time is different for a very simple reason: core and periphery countries (such as Portugal, Ireland, Greece and Spain) may now need the same medicine to recover.
The first two years of the crisis management have been shaped by sharply different economic situations within the Eurozone. On the one hand, there was the stable core with highly competitive countries like Germany who could easily overcome losses from exporting to depressed markets in the crisis-ridden periphery by exporting to fast-growing countries like China.
Front-loaded austerity policy in the periphery could be prescribed as the main instrument for them to adjust and to regain the confidence of the financial markets without serious repercussions into the core. Moreover, financial market confidence into the last safe havens in the Eurozone kept interest rates for the core country governments extremely low.
Hence, the austerity strategy was in the interests of the core country governments who were facing electorates reluctant to finance the “sinners” in the periphery.
But with China’s growth slowing slightly and core Eurozone countries like France and The Netherlands showing problems, austerity policies strike back. The German government expects not more than 2.8% export growth in 2013 and thus a negative impact of the external sector to GDP growth (-0.1%). With internal demand also expected to increase only very slowly, low growth with many additional downside risks has entered the Eurozone heartland.
Yet, exactly this situation entails the chance that Germany and other core countries will change their approach to Eurozone crisis management. In the past, many important actions that economists have demanded have first been rejected and then been implemented last minute or at least considered seriously. The more active role of the ECB and Mario Draghi’s famous assurance that the ECB will “do whatever it takes to rescue the Euro” has calmed the markets and so have plans for creating a banking union and a new fiscal compact.
Today the core countries have a much stronger incentive “to do whatever it takes” to avoid a new intensification of the Euro crisis. Hence the pressure to finish the Eurozone reforms will be very high. So expect some serious progress with these reforms in 2013.
Moreover, with the core countries at the brink of a recession or even in the middle of it, front-loaded austerity programs may be replaced by long-term deleveraging strategies which allow for more growth in the periphery and thus in the core countries. Recent IMF research on fiscal multipliers has shown how damaging an austerity program can be in the midst of a financial crisis. 2013 may bring a serious policy change here too.
Finally, in this year of general elections, Germany may even accept that boosting domestic demand may be helpful to overcome the growth weakness. The present government predictions are based on moderate wage increases within the range of productivity increases. But the unions are asking for more, and the labor markets, which face shortages in various areas of qualification may allow for it.
Peter Bofinger, a member of the German Council of Economic Advisors has voiced a (controversial) recommendation of a 5% wage increase. This could eventually not only boost German internal demand, but also help to narrow down the competitiveness divergences in the Eurozone – this time by more inflation in the core rather than by deflation and recession in the periphery.
Whatever scenario will describe the reality of 2013 more realistically, expect another interesting year for the Eurozone with many “truths” of the past thrown overboard again.