Discovering the Limits of Ordnungspolitik

by Tobias Schulze-Cleven on January 20, 2011

As the Euro crisis deepened, the German government’s crisis management became the object of increasingly intense criticism. Being perceived to have “fallen out of love with Europe,” the country seemed to be “making a huge profit at the expense of the other Europeans, while simultaneously, at the political level, relinquishing its European responsibility.” 1 Many of the individual charges directed at Germany were right on the mark, particularly those about the one-sidedness and self-serving nature of German discourse about the country’s economic renaissance, which largely failed to acknowledge the strongly positive impact of the Euro on the economy. But other accusations were remarkable for their own biases. With the often clearly defined drawbacks of German actions, it has been relatively easy to criticize them. However, given the complexity of the challenges facing the Euroarea, it is far harder to say what German positions should actually be.

This is the dilemma of German policymakers, who have to both chart a course in the face of great uncertainty internationally and also maneuver within the treacherous waters of domestic politics. Understanding Germany’s seemingly egoistic policy stances and the country’s vacillating positions on Euro governance during 2010 requires an appreciation for the tensions between the _increasing limits_ and the _continuing force_ of ordo-liberal thinking in Germany’s engagement with the European Union.

Firmly entrenched at the center of Germany’s social market economy, ordo-liberal ideology stresses the importance of stability and stipulates that governments should restrict themselves to creating a proper legal framework (Ordnungspolitik or “ordering policies”) for ensuring a healthy level of competition in the economy. At Germany’s insistence, these ideas made it into the heart of European Monetary Union, with the ECB being modeled on the German Bundesbank, a no-bailout clause and the Stability and Growth Pact (SGP) aiming to assure national-level fiscal rectitude, and strict limits on European-level fiscal policies keeping the majority of formerly soft-currency countries in the Eurogroup from establishing a “transfer-union.”

_A “Leap of Faith” Gone Sour_

By institutionalizing a common monetary policy for a set of countries with heterogeneous business cycles, fiscal policies and wage-bargaining institutions, the introduction of the Euro was truly a leap of faith. When the Euro was introduced, it was widely understood that over time new institutions would have to be developed to compensate for the loss of national monetary authority. But it remained unclear how these institutions would look or could be built.

A decade later, with new institutions still largely elusive, the Euro has produced the predicted problems: While the interest rates set by the European Central Bank (ECB) have successfully kept Europe-wide inflation rates below the inflation target of two percent, individual countries’ inflation and growth rates have continued to differ. For instance, while inflation in German was below the target for eight out of the ten years 1999-2008, the inflation rates in Ireland, Greece, Portugal and Spain exceeded the target every year. This translated into a strongly pro-cyclical monetary stance in much of Europe, with rising real interest rates (i.e. nominal rates minus inflation) that further depressed domestic demand in Germany, and falling rates for the higher-inflation Southern European countries, which fueled a consumption and housing boom.2 National wage-bargaining institutions further amplified these differences, with Northern European countries’ more coordinated wage-bargaining better suited to delivering wage moderation than the decentralized systems in Southern Europe and Ireland. As Fritz W. Scharpf had foreseen two decades ago, Germany and a few Northern countries became increasingly cost-competitive and trade imbalances _within_ the Eurozone increased.3

In theory, the European countries should have used their fiscal policies to compensate for the monetary policy mismatch, but with welfare state growth having crowded out discretionary fiscal policy, this proved difficult. Instead, counter-cyclical fiscal stimulus in those countries suffering from deflationary monetary stances quickly put them in violation of the SGP, as happened with Germany under the Schröder government. At the same time, in those countries with loose monetary stances, fiscal tightening would have required policymakers to raise taxes, cut popular welfare state programs and/or refrain from tapping into the world’s financial markets at historically low interest rates, all of which policymakers had little incentive to pursue.

_Toward New Forms of Economic Governance for EMU_

With Germany’s and France’s violation of the SGP after 2003, the deficit rules lost any legitimacy that they might have had on the European level. Unfortunately, this fact was apparently lost on many members of the German economics profession as well as German tabloid journalists, who spent much of 2010 riling up the German population against the profligate spending of “deficit sinners” in Southern Europe. With the old governance rules largely in tatters, it was far from clear how to move forward.

Even though German Chancellor Angela Merkel is reported to have warned in October that Germany could abandon the Euro, a German exit from the common currency remains highly unlikely. Not only are there are no treaty provisions and little infrastructure to see it through. Most importantly, it would bring back the problems that had originally prompted European monetary integration. For example, a reintroduced Deutschmark would immediately appreciate, putting in danger German export performance. Other countries are equally unlikely to exit EMU. Even in Greece, companies need the Euro to create the growth that is needed to enable the state to service its debt.

With the exit option off the table for all practical purposes, calls for a “real integration” or “political union” abound. But how would such a scenario look? Particularly from a German standpoint (but also for other European countries), European-level economic governance with control over wage-setting and member-states’ fiscal policies would be highly problematic, for it would infringe on Germany’s constitutionally protected principle of wage-bargaining free of state interference (Tarifautonomie) and would also constrain the democratically-legitimized power of national parliaments, which Germany’s constitutional court has also already ruled out.

Without a new master plan for the long-term governance of the Euro, the German government has concentrated on addressing international investors’ short-term fears about Europeans’ inability to manage their currency. In doing so, it has largely reacted to events, rather than proactively taken steps toward a new governance structure. Thus, the government has more or less muddled through, with a tendency to come down on issues when outside events put them on the agenda, and with a timing that has often put further stress on other European countries. For example, while Merkel’s push to make private debtors assume costs after 2013 was a reasonable one, pursuing it in the middle of worries about Ireland’s deficit could only increase the risk markup that investors demanded for holding Irish bonds.

Throughout, the government has been pulled in different directions, constrained by ordo-liberalism’s legacy in domestic politics, yet feeling compelled to openly break with the approach. For example, even though German Finance Minister Peer Steinbrück had acknowledged in the spring of 2009 the need to deal with Greece’s financial situation, it took until May 2010 to pull together a package for Greece, as well as to establish a broader temporary stabilization mechanism. It appears that the Chancellor wanted neither to attract the anger of voters about becoming Europe’s “paymaster” before the important regional elections in North Rhine-Westphalia, nor to engage in protracted battles with proponents of a maximalist interpretation of the no-bailout clause in article 125 (1) TFEU. At the same time, the entirely “un-ordo-liberal” desire to avoid putting further strain on German banks, which were exposed in both Greece and Ireland, pushed the German government toward preventing those countries from defaulting.

The tensions between the German desire to prevent moral hazard for highly indebted countries and the commitment to spare investors have produced problematic rescue packages that end up effectively strangling Greece and Ireland. Moreover, given that Greece and Ireland are charged higher interest rates than those at which Germany can borrow, the packages are structured in a way that might make them quite profitable for Germany. Indicating the government’s ambivalence about its own course, it has not even used the profitability argument to sell the rescue packages to the public.

Through much of the remainder of 2010, Germany and France have moved in lock step, seeking to work toward better economic governance. There appear no hints on Germany’s part of the former paranoia about potential French schemes to undermine stability. So, admittedly, progress has been made. But the threat of contagion has not been contained: By seeking to reverse the market logic of protecting new over old bondholders, the envisioned rules for a haircut in the stabilization mechanism after 2013 provide the ground for a domino effect playing out in slow motion. Similarly, with neither the economics nor the politics working out, the Greek and Irish packages are not sufficient for the long term.

However one cuts it, a lot more institutional innovation will be needed. Putting European economic governance on a more secure long-term footing will likely require Germany to get “ready to trade money for power” and involve further breaks with _ Ordnungspolitik._4

1. The first quote is taken from Wolfgang Proissl. 2010. _Why Germany Fell out of Love with Europe._ Brussels: Bruegel. The second quote is from Ulrike Guérot. 2010. “Germany is Europe. But why have the Germans not noticed?” _IP Global_ 6/2010: 64.

2For a detailed discussion of the mechanisms, see Henrik Enderlein. 2004. _Nationale Wirtschaftspolitik in der Europäischen Währungsunion_. Frankfurt/Main: Campus.

3See Fritz W. Scharpf. 1991. _Crisis and Choice in European Social Democracy._ Ithaca, NY: Cornell University Press. A very accessible discussion of the pro-cyclical dynamics and their effects on trade can be found in Martin Höpner. 2010. “Warum der Euro nicht funktioniert.” _Die Mitbestimmung_ 56(7/8): 48-50.

4The quote is taken from Jean Pisani-Ferry. 2010. “Foreword.” In Wolfgang Poissl. 2010. _Why Germany Fell out of Love with Europe._ Brussels: Bruegel, 3-4.



Walt 01.21.11 at 4:37 pm

This was a terrific summary of the situation.


Detlef 01.21.11 at 7:48 pm

Agree with Walt.


Oliver 01.22.11 at 9:34 am

Can somebody explain how inflation in the whole Eurozone is supposed to cure differences in competitiveness? It would deflate away debts, but as the adjustment would not involve exchange rates, it would mean that the southern members of the union would have to take an inflation of prices without adjusted wages to become competitive again.

As for inflating away debts, I have to point out:

1. Germany holds quite some foreign debts
2. Germany is an old country. Many people depend on their savings and pensions.
3. Germany is economically powerful now, but as it ages it would have problems to pay debts necessary for an even larger stimulus or large payments for defaulting nations.


Alex 01.23.11 at 11:45 am

This is actually probably the best contribution so far, and it’s Audi-VW quality.

National wage-bargaining institutions further amplified these differences, with Northern European countries’ more coordinated wage-bargaining better suited to delivering wage moderation than the decentralized systems in Southern Europe and Ireland. As Fritz W. Scharpf had foreseen two decades ago, Germany and a few Northern countries became increasingly cost-competitive and trade imbalances within the Eurozone increased

This is a really interesting point in a couple of ways. A Marxist view of this would be that it’s an example of the capitalist class co-opting the unions, but on the other hand it’s hard to say that a less “coordinated” (a heavily loaded word in German…) system like those in southern Europe was actually better at protecting the interests of workers. In fact, rather than delivering stronger advocacy, those systems seem to have delivered a pathological equilibrium with neither export success nor a better deal – being decentralised can also mean that it’s easier to pick off individual plants, craft unions, or sectors and defeat them in detail.

it would infringe on Germany’s constitutionally protected principle of wage-bargaining free of state interference (Tarifautonomie) and would also constrain the democratically-legitimized power of national parliaments

This wouldn’t, of course, prevent an informal solution – mitbestimmung at the European level – and there are various institutional mechanisms both officially and politically that could facilitate this.

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