Germans Take on French, British Debt Enthusiasts

♠ Posted by Emmanuel in , at 12/11/2008 08:59:00 AM
"Reagan proved that deficits don't matter" - Dick Cheney

If the Nobel Prize in Economics was awarded based on an idea's policymaking influence, then the US vice-president deserves a place alongside Arrow, Samuelson, and Friedman. While it is more fashionable to style today's fiscally profligate efforts as Keynesian "pump-priming" wherein public demand picks up from slackening private demand, this line of argument often degenerates into a Cheneysian-style one. Instead, the social costs of mountains of debt should be offset by social benefits of equal or greater magnitude. In few of the today's cases is this evident. Having (justly) lambasted the US example several times over, let us now turn to our German friends doing the same to their European counterparts.

A rift at the heart of the EU is now developing over beliefs about the idea that "deficits don't matter." In a previous blog post, I described how the Germans share my incredulity at the idea of further (public sector) indebtedness being the cure for problems caused by excessive (private sector) indebtedness. Nicolas Sarkozy is not leaving his post as rotating EU head quietly; as he goes, he is making potshots at Germany for its refusal to engage in a continent-wide spending spree. As Bloomberg notes, Sarkozy is perhaps misguided in cottoning up to a non-member of the European currency union in Brown's Britain (for however long he lasts as PM). European diplomats readily concede that it has been the postwar detente between France and Germany that has driven the EU agenda forward. Hence, further chilling of this relationship will have repercussions on an EU-wide level:
French President Nicolas Sarkozy is ending his six months as head of the European Union the way he began: by picking a fight with Germany. The French leader prepared for today’s Brussels summit by meeting U.K. Prime Minister Gordon Brown and freezing out German Chancellor Angela Merkel, who is resisting calls to spend more to spur growth as Europe falls into recession...

Sarkozy’s courting of the U.K. and downgrading of Germany is stirring concern across the 27-nation EU, which is rooted in the postwar reconciliation of France and Germany. From the single market and euro to succeeding waves of enlargement, the two countries have been behind every major EU advance since its founding five decades ago.

“We know very well from the history of the EU that the moving force of the development of the EU is good relations between France and Germany,” Lithuanian Prime Minister Andrius Kubilius said in an interview yesterday. “If that would not be the case at this moment, it would be really a pity.”

As chairman of the two-day summit, before handing the rotating presidency of the bloc to the Czech Republic, Sarkozy aims to persuade EU governments to fork over a total 170 billion euros ($220 billion) to battle recession. Another 30 billion euros would come from the EU’s central budgets.

France has committed 26 billion euros, pushing its budget deficit above the EU limit of 3 percent of gross domestic product in 2009, EU forecasts show. Brown put up 20 billion pounds ($29.6 billion) even after Britain recorded its biggest six-month deficit since World War II. “We want to do everything we can to move the economy forward,” he said yesterday.

In Germany, Merkel has resisted calls to go beyond a two- year 32 billion-euro program of construction investment and tax breaks. She’s concerned extra spending would bust a budget that will be in balance for the first time in 39 years in 2008. The point of every Sarkozy proposal is “to get us to pay more,” German Finance Minister Peer Steinbrueck told Die Zeit newspaper Dec. 7. He went on to attack “our British friends” for “tossing around billions” by cutting value-added-tax, a sales tax.

“Are you really going to buy a DVD player because it now costs 39.10 pounds instead of 39.90 pounds?” he told Newsweek magazine in an interview published today. “All this will do is raise Britain’s debt to a level that will take a whole generation to work off.”

Torsten Albig, Steinbrueck’s spokesman, refused to comment on a BBC News report that the U.K. Treasury was unhappy about the comments and saw Germany as “out of step” in dealing with the economic crisis.

Underscoring the divisions, Sarkozy broke with a tradition of French-German pre-summit consultations by meeting Brown and European Commission President Jose Barroso in London on Dec. 8. “Sarkozy played the short-term game of playing along with Brown when he should have been trying to repair bridges to Berlin,” said Peter Ludlow, a historian and author of “The Making of the New Europe.” “I don’t think the Anglo-French relationship is based on anything very serious at all.”

The German reaction to Merkel’s exclusion was swift. “I’ll tell you the truth: I don’t find it especially nice that Germany and the chancellor aren’t there,” Foreign Minister Frank-Walter Steinmeier told ZDF television.

With the Bundesbank predicting Germany’s economy will shrink 0.8 percent in 2009, Merkel isn’t just feeding tensions with France. She’s running a political risk by preaching balanced budgets. While her Christian Democrats currently share power with Steinmeier’s Social Democrats, the two are opponents in a national election set for September -- and the blame will fall on the woman in charge if the economy sours.

“The European crisis could be so grave that it’s leading her down the wrong path,” said Jan Techau, an EU expert at the German Council on Foreign Relations in Berlin. “If this works out, Merkel will be seen as a genius. If not, and things turn out worse, she’s going to fall flat on her face.”

Sarkozy-Merkel spats go beyond the issue of fiscal rectitude...Sarkozy has been “extremely adroit and very quick,” said Giles Merritt, secretary general of Friends of Europe, a Brussels research group. “His persistent problem seems to be that he doesn’t always bother to make sure that he’s got everybody behind him before stepping into the limelight.”

As the banking crisis unleashed a recession, Sarkozy turned to London to make common cause for fighting the economic storm. Britain’s economy will shrink 1.1 percent in 2009, while the euro region contracts 0.5 percent, the Organization for Economic Cooperation and Development predicts.

While flattery from France may burnish Brown’s standing, it won’t reorient policy in the U.K., where only 30 percent of the public regard EU membership as a “good thing,” according to an EU-wide poll. Only Latvia, with support at 29 percent, is more anti-EU.

Brown anchored his EU-skeptical credentials during 10 years as Chancellor of the Exchequer, when he frustrated then-Prime Minister Tony Blair’s brief flirtation with joining the euro. In the heat of an election campaign, which must be held by June 2010, the U.K. is likely to tilt further away from EU. “I don’t know of any British government which has not been opportunistic about Europe,” said Laurens Jan Brinkhorst, a former deputy Dutch prime minister. “The old saying -- there are no permanent allies, only permanent interests in Britain -- still applies.”
I am nonplussed by the idea that other parties may take advantage of Merkel's fiscal prudence in upcoming German elections. As the major parties there haven't called for splashing out Anglo-Saxon style, it is unlikely that even a change of government will result in a volte face in making this a campaign issue. Along this line of thinking, let us further explore the thoughts of Merkel's coalition partner and finance minister, Social Democrat Peer Steinbruck. To no one's real surprise, there is no real difference here with Merkel:
Peer Steinbrück launched an outspoken attack on Mr Brown's fiscal stimulus package, saying a cut in VAT would have little impact and predicting that the huge debts the Treasury is taking on will be a burden on the UK economy for a generation.

The remarks are an embarrassment for the Prime Minister, who has repeatedly claimed his plans have set the template that other countries are following. They came the same day Mr Brown was ridiculed in the Commons for declaring that his policies had "saved the world" [see here].

Mr Steinbrück's remarks, in an interview with Newsweek magazine, surfaced on the eve of a European Union summit where Germany is set to reject Mr Brown's appeals for others to follow his lead. Germany's chancellor, Angela Merkel, is a Conservative, but she leads a coalition government and Mr Steinbrück is from the Social Democrats, a centre-left party with links to Labour.

Britain's national debt is set to exceed £1 trillion as the Treasury borrows an extra £500 billion over the next five years, some of it paying for £20 billion of temporary tax cuts Mr Brown hopes will soften the blow of the UK recession. The heart of Mr Brown's package is the cut in VAT to 15 per cent until the end of next year, something that will cost the Treasury £12.5 billion.

Mr Steinbrück said the VAT cut would make little difference to consumer spending. He said: "Our British friends are now cutting their value-added tax. We have no idea how much of that stores will pass on to customers. Are you really going to buy a DVD player because it now costs £39.10 instead of £39.90?" He added: "All this will do is raise Britain's debt to a level that will take a whole generation to work off."

The minister also suggested Mr Brown had panicked by abandoning years of fiscal discipline and budget-balancing policies in favour of Keynesian spending financed by debt. He said: "The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking.

Mr Mr Steinbrück even likened Mr Brown's borrowing binge to the practices that helped trigger the current financial crisis. He said: "When I ask about the origins of the crisis, economists I respect tell me it is the credit-financed growth of recent years and decades. Isn't this the same mistake everyone is suddenly making again, under all the public pressure?"
Nuff said.

12/15 UPDATE: Krugman disagrees vehemently.