Austerity, Growth and Germany’s Europe Policy

A major qualm many have with the Fiscal Compact is the implication underlying it that sensible and frugal wealthy European countries such as Germany must get the irresponsible and spendthrift indebted countries to sign up to a set of guarantees before handing them more money.

Like the Fiscal Compact Treaty the Maastricht Treaty also lays out a number of fiscal rules one of which stipulates that the ratio of gross government debt to GDP must not exceed 60%. From 2004 to 2007 Ireland’s debt to GDP ratio fell from 29.4% to 24.8% and Spain’s gross government debt to GDP fell from 46.3% to 36.3%. Germany and France on the other hand, in the same period, failed to comply with the 60% of GDP gross debt limit every single year. When the crisis hit in 2008 the gross debt of nearly every EU country rose, and Ireland’s nearly doubled, yet Irish gross debt as a percentage of GDP did not overtake Germany’s until 2010[1].

While Germany herself did not manage to keep to the rules laid out in the Maastricht Treaty she now insists that Eurozone countries in severe crisis must abide by an even more stringent set of fiscal rules in order to receive future bailout money. It can be argued that it is fair for Germany to demand certain guarantees before she uses more of her money to bail them out, yet this argument assumes that German bailout money is some sort of charitable donation.

A very large proportion of the Eurozone bailouts were for the purpose of servicing debts created by private banks which borrowed excessive amounts from private (and some public) banks in France, Germany, the UK and Belgium (in that order)[2]. According to Bloomberg “irresponsible borrowers can’t exist without irresponsible lenders” and by December 2009 German banks had lent $704 billion (more than the German banks’ aggregate capital) to Greece, Ireland, Italy, Portugal and Spain[3].

German funded bailouts to states that owe excessive amounts to German banks for the purpose of debt repayment can hardly be seen as German charity. These bailouts are pre-emptive interventions to avoid the far more costly interventions that would be necessary to re-stabilise the European financial sector (particularly German, French, Belgian and British banks) if Eurozone countries began to default on their debts. Economic advisor to the German government, Peter Böfinger, summed it up when he stated that the bailouts “are first and foremost not about the problem countries but about our own banks, which hold high amounts of credit there.[4]

ECB bailouts are three year loans based on the premise that the economies of borrowing countries will have recovered sufficiently to be able to return to the bond markets and also repay their debts over time. As a solution to the crisis this approach is highly risky. This is particularly so as the time scale of debt repayment and conditions attached to these loans critically undermine the capacity of these domestic economies to recover. As Hollande argued; “I am in favour of meeting our (deficit) targets. But it’s because I am in favour of serious budget policies that I am in favour of growth because if there is no growth then no matter what we do we will not meet our debt and deficit reduction targets.”[5]

What are the alternatives to austerity?

The main alternative proposed to the imposition of austerity regimes in order to balance state budget deficits is to reduce debt through inflation. This, however, is impossible unilaterally within the common currency. Collectively it is also impossible because, for very solid historical reasons, it is unthinkable for Germany. But Germany has offered few alternative solutions beyond fiscal austerity and borrowing to pay off debt, demanding of other countries adherence to fiscal rules she has a record of not adhering to herself. Eamon Dyas, writing recently in the Irish Political Review, noted that Germany’s Europe policy in reaction to the crisis demonstrates no trace of what we have come to understand as the German social model.[6]

The German rational for this austerity driven recovery strategy is that austerity played a crucial role in rebuilding post-war Germany, particularly East Germany after the fall of the Berlin Wall. But this argument fails to remember one extremely important fact; that West Germany was only in a position to develop East Germany because of a number of injections of external capital and easily available and cheap credit. While it is true that austerity was a tool used in East Germany, this was done alongside an extensive privatisation campaign beyond any that would be possible in a modern capitalist state. This meant that a vast amount of foreign capital was injected into Germany from the early 1990s through the sale of East German property and businesses to foreign investors. It is fictitious to assume that privatisation in currently indebted countries could result in such an inflow of foreign capital as these states hold a minute proportion of the country’s property and wealth compared to East Germany’s communist economy before the 1990s.

Of the $13 billion (about $100 billion in today’s value) that the United States pledged to the Marshall plan from 1948-1951 Germany was the second largest recipient after France. This money was received in the form of grants (that did not have to be repaid) and, at the same time, the Export-Import Bank provided long-term low interest loansThese funds were handed over to governments rather than banks and the cooperation of different relevant groups such as labour leaders, government representatives and business people, was encouraged in their allocation. 

A large contributory factor to German post-war reindustrialisation were counterpart funds which used Marshall Plan aid money to establish government administered funds in each country’s local currency, the majority of which had to be invested in industry. The German government lent these funds to the private sector for rebuilding and, as the money was paid back, further loans could be issued for the same purposes. In this way the funds were repeatedly recycled and by 1996 the German ERP fund had reached a value of 23 billion Deutche Mark[7]. This system would be a very good fiscal stimulus model for Europe’s currently struggling economies rather than throwing all allocated funds into a debt pit. Maintaining a government administered fund for the purpose of providing sensible loans to small businesses, entrepreneurs and other private sector players could kick start credit starved economies in Europe. As all loans are paid back this sustainable system could use the same funds for business loans and industry development for years to come.

Reduced spending is of course necessary in a crisis, particularly in a country like Ireland where spending skyrocketed while the economy boomed. It is unrealistic to think that Ireland can maintain boom era spending in the depths of crisis but austerity alone will not alleviate the crisis. Crisis stricken European countries require similar capital injections as those received by post-war Germany in order to grow and meet their deficit targets without allowing their social systems and domestic economies to be strangled by the burden of debt repayment.

Some of these issues can be tackled politically with limited capital investment and in this lessons can be learnt from Germany’s internal social system. As consumption continues to fall across the Eurozone perhaps governments should move away from tax systems which follow the Anglo-American model of supplementing low PRSI, income and corporate taxes with high VAT rates. While VAT has been proven more often than not to act as a regressive tax, high yields of this type of tax are heavily dependent on a high level of consumer activity which is unrealistic to expect in these economic times.

The German apprenticeship model is a way in which struggling European countries could tackle unemployment, particularly youth unemployment, with little cost to the state. While it is not necessarily an easy system to introduce the moves to be made are political not financial. This would require an agreement between the private, public and education sectors and a system whereby apprenticeships across a wide range of disciplines are made available each year as an alternative to purely academic based systems of higher education. Attaching long-term internships to university courses would also greatly reduce the number of young adults graduating with no relevant work experience and therefore few relevant job prospects.


“Austerity” and “Growth” have become buzz words with little meaning. Pro-growth policies mean different things to people of different political stripes and economic ideologies. To some, pro-growth means labour flexibilisation and low corporation tax and to others it means higher wages and increased social spending to spur the internal consumer market.

Those who advocate a pure austerity line in the recovery strategy view those on the growth side as unrealistic. Those who advocate a pure anti-austerity line are unrealistic as spending cuts are an unfortunate necessity. The growth movement in Europe, however, is not against fiscal discipline but, rather, they oppose the premise that fiscal discipline alone will alleviate the crisis. What we need is to develop a healthy combination of austerity and growth orientated policies that simultaneously tackle the human cost of the crisis, the consumer spending capacity deficit, unemployment, the debt issue, industrialisation to reform economies with an unhealthy dependence on the financial sector while also developing practical apprenticeship-based vocational training systems akin to those in Germany.

Pro-growth does not necessarily mean throwing money at the situation but realising the core obstacles to recovery and tackling them with directed policies. This can include allocating a certain amount of bailout money to the creation of government administered funds for the purpose of sensible business lending as was so successfully implemented in post-war Germany but other growth orientated policies require political will rather than financial investment.

Germany seriously needs to add some of its own social policy successes to the recovery plan, including elements of its domestic social model rather than insisting purely on a policy of austerity and debt repayment. Germany’s reconstruction and reindustrialisation was based not solely on austerity but also on large injections of foreign capital into the country. This capital was used very sensibly and an extremely efficient, stable and more or less socially equitable system of capitalism was created. Germany has a lot to offer in pro-growth policies from her own history and domestic model yet so far these elements have remained absent from the debate creating the impression abroad that the aim of German policy is merely to ensure her banks are repaid. One can understand why Merkel cannot advocate costly pro-growth policies in the Eurozone as her electorate would not stand for it. But there are many growth orientated policies within the German social model that cost very little to implement and lending these elements to the discussion would serve to soften Europe’s growing distaste for German leadership as well as reminding the austerity purists that pro-growth does not always mean spending money you do not have.

Massive cuts in state spending to pay off debts incurred by private banks is a recipe for serious political and social unrest. The Marshall plan alleviated such issues in post-war Europe by allowing governments to relax their austerity policies. The motive behind this aid package was to quell the rising support for communism in war torn Europe but the effect cannot be denied. The people of Europe embraced the free market economic model in exchange for increased social spending and the creation of the welfare state. Economic stimulus based on grants and long term low interest loans created the fastest period of growth in European history thus allowing the continuation of the welfare state and general acceptance of the market economic model. If we allow the current recovery strategy to hollow out the European welfare state, civil unrest and radicalised politics are sure to follow, on both the left and right of the political spectrum. The beginning of this process at its extreme end can be viewed in the recent Greek elections but the recent rise in radical left and right wing parties since the beginning of the crisis is evident across Europe from Finland and France to the Netherlands.

Given the interdependence and common interests of the Eurozone member states, those states with the economic power, credit and capital capacity should not have to wait for a new political spectre to emerge from the chaos before they start resourcing programmes for the economic revival of the Eurozone and the securing of the European social model.  

Jenny O’Connor is an International Relations graduate with a specialisation in interstate economic relations and regional integration She lives in Dublin and can be reached through her website.

A different version of this essay originally appeared in the print version of the Irish Political Review.


[2] Chatterjee, Pratap. ‘Bailing out Germany: The Story Behind the European Financial Crisis.’ May 28th 2012

[3] Bloomberg. ‘Hey Germany: You Got a Bailout Too.’ May 24th 2012

[4] Chatterjee, Pratap. ‘Bailing out Germany: The Story Behind the European Financial Crisis.’ May 28th 2012 Quoted from Spiegel’

[5] Reuters. ‘Highlights- Merkel and Hollande comments at news conference.’ May 15th 2012

[6] Eamon. Dyas. ‘The Stability Treaty Referendum: the case for a “No” vote’. Irish Political Review

[7] Junker, Detlef (2004). ‘The United States and Germany in the Era of the Cold War, 1945-1990: 1945-1968.’ Cambridge University Press pg 306